≈ High P/E = Lower Return ≈
Today’s message complements yesterday’s Tackle Today, highlighting the S&P 500’s high P/E ratio. Here’s how I think about valuation. It matters little, if at all, in the short-run (say, 1 year). But it does matter some in the intermediate-term (5 years).
Let me elaborate.
Study the chart of the day for a moment. It plots the S&P 500 P/E ratio on the horizontal axis. More expensive markets are on the right, cheaper ones are on the left. The vertical axis plots market returns over the next year (left chart) and five years (right chart). The red arrow illustrates where we are Today with an S&P 500 P/E of 21.9.
The gray dots show historical market returns when the S&P was at various P/E levels. Note how spread out they are on the left chart. Sometimes buying at high valuations gave you a really good rate of return one year later. Other times it gave you a bad return. The dispersion between outcomes is quite large.
This is why it’s impossible to say that buying richly priced stocks is a bad idea. In the short run, you get good outcomes just about as often as bad.
The intermediate-term is different. That’s the chart on the right. Note how the dispersion on the scatterplot tightens. Generally, buying at low valuations generates higher 5-year returns. Buying at high valuations yields lower 5-year returns.
If you want to be pessimistic about the market’s average annual return over the next five years, history backs you up. The more interesting question is what you’re going to do about it.
Chart of the Day
P/E Ratio and Subsequent Returns
Okay, bears. You can convince me that today’s high market valuation lowers forward returns if the time frame is five years. But, I’m not personally investing money for five years. I’m investing for five decades, if not longer. Thus, I find bearish arguments that hinge on the P/E ratio unconvincing.
Video of the day
Join Coach Tyler, Greg and Mark for another edition of Trade Masters
Traders Lounge 11 AM EST
Join the coaches in this live lounge, ask questions, discuss ideas or just sit back and listen to veteran traders discuss market conditions.
Halftime Report 12:30 PM EST
The Halftime Report starts at 12:30 EST and covers what news is driving the market, chart analysis from the movers and shakers of the day and fun in a way that only Matt and Tim can deliver.
Cash Flow Club 8:30 PM EST
Join Greg Holmes as he hosts the weekly cash flow blub
Financial freedom is a journey
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.