S&P 500 Long Term P/E Ratio

Warren Buffet's encouraging op-ed in the New York Times today may have inspired some buyers this morning, but after a world-wide credit crisis, weakening home prices, and the crumbling of several of the world's most prestigious financial institutions, how much will investors really be willing to pay for earnings.  Shown below is the 12 month trailing P/E ratio for the S&P 500, its current level and the 5 year average.  The average has been declining since the first quarter of 2004, where it peaked, but this could also be a cyclical signal that earnings will have to become much more robust before buyers are willing to bet on future earnings.  A quick recession that's over before it starts (on an announced basis) would be encouraging.  In any case, the market's P/E ratio is still above its long-term lows, but below any kind of inflated state and continued healthy earnings (like those of Google and IBM) will be a long term positive once the fear leaves the market.

Comments

[Aldous]

It would be very nice to see this chart adjusted for inflation. The period of very low P/E's in the '70 & '80s corresponds to a period of high inflation and therefore low real earnings yield and so results in higher real P/E's.

A series of real P/E's might show that the market is currently cheap compared to its historic average.

[Eric]

Anything less than Robert Shiller's data on PE ratios is a waste of time.

http://www.econ.yale.edu/~shiller/data/ie_data.xls
http://www.econ.yale.edu/~shiller/data/ie_data.htm

[baker]

isn't price quoted in current dollars as well as earnings quoted in current dollar so that when you divide one by other they would cancel, thus making inflation irrelevant.

[electron]

The reason that P/E is affected by inflation is that competing investments (bonds etc.) are returning higher rates. This depresses stock prices and thereby P/E ratios.

http://en.wikipedia.org/wiki/PE_ratio

[Fred]

You don't adjust PE ratios for inflation but inflation does affect what is an acceptable PE ratio. In periods of high inflation you can easily find high rates of returns elsewhere so stock prices drop, not being in great demand.

[Brian Madison]

Seriously, L, please update this with new commentary now that the TMM index P/E is 145-ish.

Time to start investing in gold, ammo and canned goods?

[Brian Madison]

That's TTM, of course.

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