Are Stocks Cheap or Expensive Now?
One common fact going around recently is that stocks have a relatively low P/E but this is because they have record earnings. If those earnings were to fall back to lower levels in the near future, the value of the stocks would actually be less than it seems to be now.
I recently saw an alarming chart to this effect, showing that US quarterly corporate profits rose from around $375B in 1988 to $825B in 1997, and then a few years later started a roller-coaster ride shooting up to $1875B in 2006, falling down to $875B in 2009, and then going back over $1900B now. Such a quick rise would seem a bit too fast and they might fall again.
So which is it? Are stocks cheap because of their relatively low P/E ratio or expensive because the earnings are too high? This chart based on 50 years of S&P 500 data might help to get a better look:
(Data obtained from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm. Yields are on the left side and all other numbers are on the right side.)
It shows that as of the end of 2011, the earnings were barely above trend after hitting a peak around 2006 and falling until 2009. The earnings yield looks relatively good on here too, almost the opposite of what it was in 1999. The dividend yield seems to be at a fairly low level though.
The index level has risen since the end of the year and things may be a bit less attractive now, but it doesn’t look like the S&P 500 earnings are unusually high so it still seems reasonable to measure prices relative to that.