It has been almost two years since the last time we had a 10%+ stock market correction. The latest S&P 500 correction of 10.2% was spread over about 9 days…let’s call it from the late-January high to the early-February low. People may get all twisted up over “intra-day” basis index level, but let’s just go with my days and amounts above. (OKAY, FINE. On an intra-day basis, the S&P 500 corrected 11.8% over 10 days).
However, the most interesting thing has been the correction in VALUATION. The S&P 500 forward price/earnings (P/E) multiple peaked at 18.5x on December 18th, 2017. Remember, this is just a number that is obtained by dividing the price of the S&P 500 by the earnings projected for the next 12 months. Hence – “forward earnings”.
By March 28th, it shrank to 15.9x…a 14.3% decrease. (Source: FACTSET)
When a P/E ratio decreases, it means it takes less money to buy a dollar of earnings that a company produces. So mathematically, the way the P/E ratio goes from 18.5x to 15.9x is by of one of three things happening – the price of the S&P 500 goes down, the earnings go up, or both.
Well we know that the price has come down, right? At least 10.2% or 11.8%, depending on how geeky you want to be. But while the price has been coming down, forward earnings have been ALSO marching up.
If you liked the market in December when it took $18.50 to buy $1.00 of the S&P 500’s projected 12-month future earnings but you hate it now when it only takes $14.30 to buy that same $1.00, you may want to reconsider things. Stocks are now on sale relative to December prices and earnings are projected to increase 18% year over year.
Remember the theory of Loss Aversion – where losses hurt more than gains.
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Keep looking forward,
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