The Big P/E 10 At The Small End Of Town

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Includes: FLQS, FYX, JKJ, SCHA, SMLF, VB
by: Topdown Charts

Summary

P/E 10 or cyclically adjusted P/E ratio is trading around record highs for small caps.

The P/E 10 for small caps is also materially higher than that of large caps.

Thus, small caps likely to see poor absolute and relative performance over the longer term.

A number of analysts and commentators have been discussing the increasingly high levels of the "Shiller P/E," also known as CAPE or P/E 10, for the S&P 500. Indeed, the CAPE has historically been a good predictor of longer-term forward equity market returns.

But in this article, we'll take a look at the P/E 10 for the smaller end of town. Instead of the S&P 500, we'll examine the P/E 10 for the S&P 600.

The chart comes from a broader discussion on the outlook for US Small Cap Stocks in the latest edition of the Weekly Macro Themes report.

The chart shows the P/E 10 for small caps vs. large caps, and there is a considerable gap between them, with small caps trading around a record high valuation level.

The P/E 10 as calculated for this graph is price divided by the past 10 years' earnings (using historical price and earnings data from Thomson Reuters Datastream).

It is quite remarkable how far small cap stocks have run on a P/E 10 basis, both relative to large caps, and relative to history. They only previously approached these levels just prior to the financial crisis, and just before the 2015/16 market turmoil. They were left behind during the dot-com boom, but that's an extreme and different story.

In any case, at least for the S&P 500, several studies have shown that the higher the P/E 10, all else equal, the lower the future longer-term expected returns. Given that small caps are trading at a higher P10 than usual and higher vs. large caps, it would be reasonable to expect worse longer-term future performance in absolute and relative terms.

This article originally appeared as a submission at See It Market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.