A PE Roadmap

Here's a way to think about the markets in the coming months.  Think of this as an earnings roadmap to chart various levels of valuation on markets, but this time using forward earnings as a guideline for how things might play out.  What I've done is take a weekly chart of the S&P 500 ETF, SPY, and put different Price to Earnings Ratio {PE} numbers on the charts.  We're using current consensus estimates of $158 on the index.  Here's what we can see.  

In the declines so far the market has found support at a level closely corresponding with a 16 PE.    That doesn't seem so unreasonable given the low interest rate environment we are still in and the robust economy we're experiencing.  Earlier in the year we traded at a PE closer to 18 {Not pictured on the chart}.  To get to a 15 PE the market would have to fall another 7.5% from current levels.  A 14 PE would amount to a decline of about 14% from here and a 13 PE translates to a further 20% decline.  Probability suggests that given what we currently know about the state of the economy we're unlikely to see such a drastic decline as those 13 and 14 PE numbers would suggest.  I'm putting this up to give you some idea of what's possible, not what is going to happen.  The environment we're in is suggestive of stocks trading somewhere in that 15 to 17 PE range.  

Keep in mind those PE levels could rise or fall depending on revisions to earnings.  The good news for stocks is that earnings have been revised significantly higher since the beginning of the year.  Also about mid-year investors will start paying more attention to 2019 earnings and right now those numbers are looking about 10% higher than the estimates for 2017.  If they pan out then stocks aren't as expensive right now as some might suggest.  Of course we'll have to wait and see.

As a reminder I'm out the rest of the week attending a funeral and then some meetings.  Posting will resume early next week.  

The chart above is from Tradingview.com, although the annotations are mine.

Long ETFs related to the S&P 500 in client and personal accounts.  Short S&P 500 in a personal account as part of a separate individual strategy.