What are P/E Ratios Telling Us?

I have found using earnings and P/E's to establish entry points in broad market positions difficult.  For example, if investors wait for PE multiples to arrive at or near 15 (historical average of as reported P/E ratios), they may find the market has left them behind.  In the last bear market the as reported P/E did not hit a low until the end of 2006 at 17.4, well after markets advanced from lows hit in late 2002.

I do expect more downward pressure on U.S. stocks base on the contraction in consumer spending that is likely to stay with us until the housing and employment situations improve.  I'm not sure we will get to a level where the P/E on as reported earnings will hit 15. With huge amounts of cash sitting on sidelines looking for bargains it may be difficult for stocks to fall much further.  I would argue the risk level for starting to re-enter this market is fairly low.   We have had a healthy 50% decline from market highs.  Can it go lower?  Sure, with the risk that we become a repeat of Japan in the 90's.

Here is a look at the Historical and Estimated "As Reported Earnings" for the S&P 500

Year - Earnings - P/E

2010 - $39.59 - 19.93

2009 - $32.41 - 24.34<<

2008 - $27.69 - 28.49<<

2007 - $66.18 - 22.19<<

2006 - $81.51 - 17.40*

2005 - $69.93 - 17.85

2004 - $58.88 - 20.70

2003 - $48.74 - 22.81

2002 - $27.59 - 31.89<

2001 - $24.69 - 46.50<

2000 - $50.00 - 26.41<

1999 - $48.17 - 30.50

1998 - $37.71 - 32.60

Current and future year P/E based on a price of 789

It thought this data was interesting because, as I noted earlier, it shows that the low P/E in 2006 took place when earnings growth accelerated more quickly than stock prices.  This took place long after the market had bottomed.  I also think the 2000-2002 earnings levels are helpful when looking at current and near term projections for earnings.  When viewed from this lens the current valuation does not look nearly as bad.  Other market recoveries, however, may have taken place closer to the bottoming of the P/E ratio.

The difference in our current environment compared to the last bear market is the magnitude of our economic woes. They are systemic and global.  It is best then, to proceed with caution.