Market PE Revisited

Today's chart comes from Chart of the Day and revisits the market's Price to Earnings Ratio, This is what they say:

"{This Chart} illustrates how the recent rise in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). Notice how investors were willing to pay much more for one dollar of earnings during the dot-com boom, the dot-com bust and financial crisis. Currently, with 94% of US corporations having reported for Q4 2010, the PE ratio stands at 17 which is a relatively low level when compared to the past two decades."

My thoughts: I can't be sure but I'm guessing this chart information is based on a trailing year's PE on the market. Current S&P 500 estimates for 2011 are ranging between $92-$94 on the index. That means that the S&P is currently trading with about a 14 Price to Earnings ratio on these forward earnings. Assuming these earnings estimates hold and are not revised down and also assuming that the market would trade at the same level of valuation mentioned above {17 times trailing 2011 estimates}, then on this analysis the market as represented by the S&P 500 could be worth somewhere in the 1500 range 12-18 months out. I'm not convinced we'll get to that point by the end of next February but I still think there is the potential for stocks to trade between 1,350-1,400 by the end of this year. I also think that all things being equal, that stocks have the potential to trade around the 1,500 level by year end 2012. Are Stocks Cheap {Part II}

Given that we are at 1,320 on the S&P right now there are only a few possibilities that can occur. The first is that my valuation estimates are too conservative for this year and need to be revised higher. The second is that since stocks have been in a sustained rally since Labor Day and are up just under 5% for the year, that we are close to a market ceiling for awhile and some sort of pause or retracement is likely at this point. Finally it could also be that both of the above are correct. That is that stocks could rest for a bit now {remember that securities can correct by price as well as time}, find a level of equilibrium and then rally hard at some point later in the year.

It is too soon to say which of these scenarios will happen. Also the analysis above assumes that our economy continues to grow between a 2-4% rate of GDP this year. All bets are off if the economy shows evidence of weakening or some outside event {Egypt, Libya or possibility Saudi Arabia} washes aboard sending all of our analysis up for grabs.

That being said I have raised a bit more cash in risk appropriate accounts. Namely I have pieced off small amounts of energy ETFs. This is more of a rebalancing as these positions have grown too large relative to their account percentage targets. Some of these have rallied much more than the market since the recent rally began.

I haven't redeployed that cash yet and am unlikely to do so until my indicators show us that we are in a more favorable risk/reward situation for that money. In some of our more aggressive strategies I may use that cash on an opportunistic basis but I am content for now to let cash set for the most part on the sidelines.

Link: Chart of the Day: Market PE

*Long ETFs related to the S&P 500 in client and personal accounts.