Continuing on the theme of earnings trends in the S&P 500
(INDEXSP:.INX), is the S&P 500 index historically cheap or expensive given the current level of earnings?
Here is a 15-year chart of S&P 500 component earnings on a quarterly basis:
In the last four quarters (not including the fourth quarter of 2012), S&P 500 index components have earned 24.37, 25.59, 25.72, and 26.30, for a total of 101.98. With the current index level around 1500, that gives a trailing P/E of 14.71, not terribly cheap or rich by historical standards.
What’s perhaps more interesting about the above chart is the historical volatility of earnings quarter-to-quarter. From mid-2007 to the end of 2008, quarterly earnings for the index collapsed from near 25 to near 5. However, by the end of 2011, quarterly earnings were making new highs again, an enormous recovery in the earnings power of S&P 500 companies.
From the current vantage point, the S&P 500 at 1500 seems more fairly valued than its previous visits to this level in 2000 and 2007. But market participants shouldn’t place too much faith in backward-looking earnings as a justification to buy stocks. As prior declines have demonstrated, the earnings outlook can change quite rapidly from one of gradual growth to outright contraction.
Having said all that, ignore earnings results at your own risk. Not surprisingly, over a long period of time, the stock market’s fluctuations have been closely correlated to earnings results. Even during times of seemingly peak macro uncertainty, the market has tended to eventually trade up or down based on underlying earnings momentum. With earnings relatively flat for the past year and a half, the next trend in corporate earnings is more murky than usual.
This item by Enis Taner was originally published on RiskReversal.com
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