S&P 500 Now Sporting a P/E of 21: Bad News for 5-Year Forward Returns

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Includes: DIA, EPI, IFN, INDY, IVV, IWV, PIN, QQQ, SPY
by: David Hunkar

According to David Rosenberg of money manager Gluskin Sheff, the U.S. stock market is overvalued by 35% based on Shiller P/E ratios.

The S&P 500 is up 9% YTD and most stocks have recovered strongly since the March lows of last year. The current P/E of the S&P 500 is 21. However is this the time to invest in U.S. stocks?

According to an article in MoneyWeek, the current P/E of U.S. stocks is about 22. Historically when the P/E ratio exceeds 20, stock investments have lost money over the next five years. Investor Jeremy Grantham predicts a yearly return of just 0.40% for the next seven years. When inflation is taken into account, investors would lose money if they invested in the markets now.

PE-Ratio-Historical-US-Markets

The above chart shows that stocks traded above 20 times earnings before the big crashes of 1929, the late 1960s and 2000.

Another chart from Societe Generale below shows that the cyclically-adjusted P/E of the S&P 500 is now over 20. This ratio is adjusted for economic cycles by taking an average of earnings over the past ten years.

PE-Ratio-of-US-Stocks

Source: US equity bulls are pricing in Nirvana, MoneyWeek

The above charts confirm that U.S. stocks are not undervalued based on the factors noted. Further rises in equity prices have to be accompanied by a rise in earnings.

P/E ratios have been expanding in other markets as well though earnings have not grown significantly. For example, among the emerging markets, the P/E of BSE 500 stocks in India has shot up from 11.7 times earnings (12-month trailing earnings) in March 2009 to over 20 last month. In 2009, when the total net profits of the BSE 500 companies grew by 30%, their market capitalization increased by 130% showing the irrational exuberance of investors.