When You’re Crying You Should Be Buying…When You’re Yelling You Should Be Selling!
We don’t know who said that but it is the absolute best piece of investment wisdom we have ever come across. Today we will look at one of the most popular valuation indicators for stock investing. The PE Ratio is the stock price to per share earnings ratio. Several studies indicate that this indicator is also one of the indicators that most closely correlates to future returns. The S&P 500 Case/Shiller PE Ratio is particularly effective since it looks over 10 years of history and is great at smoothing out short-term bumps. In short, the higher the current PE Ratio the lower the future expected returns are likely to be and vice versa.
So where is the S&P 500 Case/Shiller PE Ratio right now? Unfortunately (or is it fortunately), the current ratio is extremely high. Only two times in history has it been higher: 1) Right before the stock market crash of 1929 and 2) During the 2000 Internet Bubble. Both of these times the valuation of the stock market was at historical highs (well above historical highs). We know what happened next! Since 2008 the S&P 500 Case/Shiller PE Ratio has doubled from 15 to over 30. Given this information we should expect that the next 10 years will have real annualized returns of less than 5% for stocks (which is well below the historical average of 11%+).
MyMoneyTrainers Take: With stock valuations approaching near historic highs the likelihood of lower than average future returns (or even a full-blown market correction) is increased.
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