P/E ratios drop back to more realistic levels

Source: www.chartoftheday.comS&P 500 pe ratio Dec10.pngThe price/earnings (P/E) ratio is the most fundamental measure of stock market value. If investors are optimistic, they will pay a high price per unit of earnings. If they are cautious, then the ratio will be lower.

Thus the above chart from chartoftheday.com highlights a very significant secular change underway in investor mindsets. It shows the P/E ratio for the US S&P 500 since 1900. And for most of this time the ratio traded between a low of ~7 (green line) and a high of ~22 (red line).

But the rise of the Baby Boomers in the 1980s, which greatly increased stock market investment, took the ratio to a completely new level over the past 20 years. The dot-com bubble took the ratio over 40, and the collapse in earnings during the Crisis left it even higher.

Now it seems to be drifting back towards more realistic levels again. This probably demonstrates the impact of the ageing of the Baby Boomers, who are now in their 50s and 60s. As the blog argued in the Financial Times in September, their increasing life expectancy changes the rules of the game as regards the merits of stock versus bond market investment.

By comparison with stock market volatility, the certainty of a 4% yield for 30 years from a G7 government bond becomes quite an attractive proposition.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. He also serves as a Global Expert for the World Economic Forum. The aim of this blog is to share ideas about the influences that may shape the chemical industry and the global economy over the next 12 – 18 months. It looks behind today’s headlines, to understand what may happen next in critical areas such as oil prices, China and Emerging Markets, currencies, autos, housing, economic growth and the environment. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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