S&P 500 P/E Ratio: A Cause For Concern?

Nov. 30, 2017 3:54 PM ETSPY, TLT10 Comments
MacroForce profile picture


  • Here are some reasons why a historically high P/E may not be a major cause for concern yet.
  • Historically low interest rates, subdued inflation and rising corporate earnings all play a part.
  • P/E still matters. What the historical data does clearly show is that higher current valuation levels do tend to correspond with low future financial returns.

Valuation metrics have always been somewhat subjective and open for interpretation. Such is their nature. Here are some reasons why a historically high P/E may not be a major cause for concern yet.

Historically Low Interest Rates

From a valuation perspective, it’s intuitive to think that somewhat higher valuations arising from a lower discount rate are justified, as investors are more willing to pay a higher price for more valuable future earnings. But to what extent?

After nearly a decade of interest rates near-zero, maybe the way valuations are viewed should be different. Sure, the Fed has been embarking on a tightening cycle over the past two years, with the fourth such rate hike having occurred in June, but yields still remain near historic lows.

Relative to other periods over the previous forty years, higher valuations have occurred during periods with higher interest rates. The current P/E ratio is only about 14% richer than what the average was during the last economic expansion from 2001-2007. And yet yields were twice as high (4-5% back then versus the current 2.38% on the 10-year U.S. Treasury). Similarly, higher valuations occurred both in the early and late 90s, during environments when yields were 2-3x higher than today’s levels.

Source: Data from Bloomberg as of November 28, 2017; proprietary chart

The other side of the coin is that lower yields make competing investments such as bonds less attractive. With the current 10-year Treasury paying 2.38%, it’s no surprise that investors hungry for higher returns may opt for equities. This notion is even more pronounced from a global perspective, where 10-year Bunds and Japanese bonds yield just 0.388% and 0.04%, respectively. Of course, from a domestic investor perspective, this was an even stronger argument before the backup in yields began in the summer of 2016 when 10-year was hovering at levels below 1.4%. If anything, the

This article was written by

MacroForce profile picture
Expressing macro plays through ETFs.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute investment advice. I am passing along the results of my research on the subject. Any investor who finds these results intriguing will certainly want to do all due diligence to determine if any security mentioned here is suitable for his or her portfolio.

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