The historical average Price/Earnings ratio for the S&P 500 is 14.7. After hitting 120 at the end of May and 134 at the end of June it now stands at a mind-boggling 144. That’s bad – it means the S&P 500 and by extension the stock market in general is wildly overpriced based on current earnings.
If the P/E ratio is so lousy why is the stock market so high? The most likely answer is that the stock market is being pumped up by loose money provided by the Federal Reserve. All of those billions and trillions of dollars have to go somewhere. Once all that liquidity leaves the stock market stocks are going to take a tumble.
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“The Market” is being pumped up by financial manipulation, while real earnings resulting from regular business operations are generally quite low. Stories of how XYZ Corp beat estimates by a penny per share are much ballyhooed, ignoring the fall in earnings, careful setting of estimate levels, and internal adjustment of finances. Even in normal times it’s not hard to find a stock with P/E ratio in triple digits. If ZYXCO makes 1/2 cent a share and sells for 97 cents there’s your ratio. Now the difference is, it’s not just isolated stocks that are like this.
Interesting that there’s a lot of discussion about how the massive liquidity created by China’s central bank has gone straight to its stock market (with all the related predictions of a giant crash when the flow stops), and virtually none about the exact same phenomenon in the U.S.
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