S&P 500 market valuations (based on forward P/E) have fallen from 20 to 16.7 since the start of 2018.
The drop is due to an increase in earnings estimates and drop in market prices (about 2 points). If you look at the below chart which goes back to 2007, the stock market valuation has fallen significantly and is now within one standard deviation of the historical mean.
However, some caution is necessary. The above uses estimated future earnings.
If we look at trailing earnings, the picture is different, as valuations are more than one standard deviation outside of the historical average.
So, markets are closer to average valuation based on the idea that tax cuts and a relatively strong economy will deliver solid earnings growth. Though this expansion is aging, we see no signs of a recession.
Additionally, it appears some of the market froth has been removed. Some of the “less rationale” investments have shown even larger corrections than the broad market – Bitcoin, Tesla and some tech stocks.
This is the type of environment where we should benefit from positions in quality names.
Peter Malone, CFA
Research Analyst
Direct: 617.226.0030
Fax: 617.523.8118
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