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S&P 500 PE Ratio - June 2009

In  February 2009, I asked the question in an article on the same subject, is the current S&P 500 PE ratio trending down or up? If you are like most investors, then you believe the S&P 500 PE ratio is trending down as the stock market plunges. After all, the P, or price part of the ratio was falling.

The answer: the S&P 500 PE ratio was trending up. After the earnings result for the quarter ending March 31, 2009, the PE ratio was even higher. The reason is the denominator E, or earnings in the PE ratio is falling while the price is rising. For these calculations the 919.14 closing price of the S&P 500 on May 29, 2009 is used.

With 99% of all S&P 500 companies reporting, the as reported earnings for the March quarter is $7.61 according to Standard & Poor’s. As shown on the chart below the S&P 500 PE ratio has risen to 132 for the quarter ending March 2009. According to Standard & Poor’s estimates for the June and September 2009 quarters are 3,500 and -301 respectively. These two values reflect the serious losses incurred in December 2008 combined with the anemic earnings performance since then. I removed these numbers from the chart as they skewed the chart significantly.

S&P 500 PE ratio chart June 2009

It is interesting to note that the forecast for the S&P 500 Index PE ratio rises so much in 2010. This is driven by two factors. First, Standard & Poor’s forecasts $34.61 earnings for 2010. This is the lowest since the early 1990’s when the S&P traded in the 400 to 600 range. Second, to calculate the PE ratio, Standard & Poor’s uses the most recent closing price for the index, which was 919.14 on May 29, 2009. By holding the P constant and lowering the E, you have to get a higher PE ratio.

As we have seen, PE ratios often rise sharply following a recession. Several quarters after the recession is over, the PE ratio then turns back down, reflecting the rise in earnings, with the price either remaining constant or continuing to fall.

Yale University Professor Robert J. Shiller, author of Irrational Exuberance: Second Edition uses a modified PE ratio that smoothes out the volatility in the ratio. The denominator of this modified ratio is average inflation-adjusted earnings over the trailing 10 years. Shiller calls this modified ratio "p/e10." Using this data the modified ratio “p/e10” produces a PE ratio of slightly over 15, which is very close to the median of 15.7. In December 2007, the beginning of the current recession, the “p/e 10” was 25.95. Since markets tend to cycle above and below the median, we should expect the “p/e 10” to fall further before turning back up.

Is the S&P 500 Going Lower

The U.S. has had three recessions since 1988 according to the National Bureau of Economic Research, the group that determines when the U.S. has had a recession. These recessions are depicted above in red. In the recession of 1990 – 1991, the PE ratio began to climb before the end of the recession. Following the end of the 2001 recession, the S&P 500 fell another 200 points before rebounding. So far in the recession of 12/2007 - ?, the S&P 500 has continued to fall.

Does this mean the market is going lower? Not necessarily. As shown in the chart below of the S&P 500 index, the index continued to retreat after the 2001 recession. On the other hand after the recession of 1990 – 1991, the S&P 500 rose slowly. Besides, we do not know when the current recession will end.

Looking at the earnings forecast from Standard & Poor’s we might be able to assess which way the S&P 500 will likely move. The table below uses the trailing four-quarter earnings from Standard & Poor’s. It then applies a PE ratio to derive the S&P 500 index. When looking at the table, keep in mind that the median PE ratio is 15.7. The PE ratio is mean reverting, so we should expect it to fall further, possibly to 10. In addition the very low S&P Trailing Earnings for June and September 2009 are due to the large loss reported in December 2008 quarter.

S&P 500 based on Estimated Earnings


S&P Trailing

PE Ratio









































































The low earnings for June and December 2009 are the reason Standard & Poor’s reports the skewed PE ratio of greater than 3,500 for June 2009 and -301 for September 2009.

Using the December 2009 quarter the earnings forecast $27.47 and a PE ratio of 30 gives us a target price for the S&P 500 index of 824. On Wednesday June 3, 2009, the S&P closed at 931 more than 100 points above a PE of 30.

This examination of earnings and PE ratios is telling us to expect a lower S&P 500 index throughout 2009. How far it will go down depends on several factors. First, are the earnings forecast correct? Investors should monitor earnings expectations throughout the year, looking for any changes either up or down. In February 2009, Standards & Poor’s estimated that the trailing earnings would be $13.47 vs. the current estimate of $27.47. In February 2009, the estimate for the trailing four-quarter earnings was $32.41 vs. $29.48 now. The estimates for all of 2010 are lower now than they were in February, indicating S&P is not expecting a robust recovery.

Second, evaluate your PE assumptions based on the outlook for the economy and the markets. If earnings are running above the forecast from Standard & Poor’s, then you should expect the PE ratio to rise eventually. On the other hand, if earnings expectations are falling, then you should expect the PE ratio to fall further. In each case, any move in the PE ratio will tend to move more slowly. The median S&P PE ratio is 15.7. Using December 2009 trailing four-quarter earnings of $27.46 times the median PE ratio of 15.7 gives us an S&P price of 431.

It is difficult to justify an S&P 500 PE ratio of greater than 30 when the economy is still in a recession and the recovery is likely to be at a slower pace than in the past. This will put downward pressure on the S&P 500 for the rest of 2009 and 2010.

As investors, we should assume that the trend for the S&P 500 is still down. It will be important to monitor the performance of the S&P 500 companies earnings announcements during the next several quarters to see how they match up to the forecast.

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