Monthly Brief December 2019 – S&P 500 Index: Price-to-Earnings Ratio

Monthly Brief December 2019 – S&P 500 Index: Price-to-Earnings Ratio


How do we best characterize 2019?

  • Was it the year that the S&P 500 Index had one of its strongest years with a 31.5% total return?  Or, was it the year that the S&P 500 Index struggled until early October to regain and breakout above its prior year high?  Or, was it the year the S&P 500 Index finished 10.9% above its previous year high set in September 2018?
  • Was it the year US equity funds saw over $213.9 billion in net inflows?1  Or, the year which barely recouped the net outflows from equity funds during 2018’s fourth quarter alone ($199.9 billion)?2
  • Maybe it was the year that “progress” was made in the trade dispute with China?  Or, maybe it was the year that the trade dispute with China was unable to be resolved?

While investors’ perceptions may characterize the same events in different ways, one point (and a very significant one) that can be agreed upon is that 2019 was a year when global central banks further stepped up their stimulative support of the global economy, or at least of the capital markets.  The Federal Reserve reversed course and reduced the fed funds rate, signaling their intentions to be responsive to investors’ concerns that had been expressed during 2018’s fourth quarter turmoil.  

We now enter 2020 with many of the same issues not yet fully resolved, plus a looming contentious presidential election before us.  But, as for 2019, the responses of policymakers, business leaders and the global capital markets to the many global risks has encouraged investors to cautiously move back into the markets and, as the year ended, the bellwether S&P 500 Index reached new highs.  Yet, further gains will be susceptible to many of the same political and economic challenges the world has been dealing with for too many years.  May 2020 be the year we see fruitful and peaceful progress (or even resolutions!) to these issues.

1 Investment Company Institute: Combined Estimated Long-Term Flows and ETF Net Issuance as of 12/24/19
2 Investment Company Institute: Combined Estimated Long-Term Flows and ETF Net Issuance as of 12/31/18

CHART OF INTEREST – S&P 500 Index: Price-to-Earnings Ratio

2019’s stock market gains have left some wondering if the market has moved too far, too fast.  For the S&P 500 Index, while the year’s gains were impressive, the first 9+ months served to “only” recapture the 2018 market high.  But the 10%+ gains during the final quarter of 2019 certainly justifies this question, particularly considering the uncertainty due to global economic and political tensions.

As a very basic measure of valuation, the price-to-earnings ratio, or P/E ratio, provides a high-level look at investors’ attitude toward the future by calculating how much they are willing to pay for $1 of earnings. And, with investors considering both current earnings and the outlook for future earnings, stocks typically trade at a multiple to current earnings.  

Assessing the P/E ratio relative to historyhas proven to be a helpful approach as it provides context regarding investors’ perceptions of the current environment and future expectations.  The accompanying chart examines this relationship for the S&P 500 Index over the past 25 years.  The late ‘90s are remembered as a period with high levels of speculation, resulting in a P/E ratio of nearly 30 (i.e. investors were willing to pay nearly 30 times the broad market’s current earnings!).  The current P/E ratio of 21 suggests optimism has been on the rise, yet it is only slightly above the 25-year average of just under 20 and well below the speculative levels of the late ‘90s. Today’s conditions are reasonable, yet do bear watching as 2019’s year-end earnings and forecasts are announced.

James Ferrin, CFA
Chief Investment Officer

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