Generational Dynamics

S&P 500 Price/Earnings ratio rockets to highest value in years

As regular readers know, Generational Dynamics predicts that we're headed for a global financial panic and crisis. According to Friday's Wall Street Journal, the S&P 500 Price/Earnings index (stock valuations index) on Friday morning (April 22) was at an astronomically high 24.11. This is far above the historical average of 14, indicating that the stock market is growing quickly, and could burst at any time. Generational Dynamics predicts that the P/E ratio will fall to the 5-6 range or lower, which is where it was as recently as 1982, resulting in a Dow Jones Industrial Average of 3000 or lower.

 

The rapidly rising P/E ratio is a sure sign of trouble. The last time that the P/E ratio rose above 24 was in April 2008. For the year following, the Dow Jones Industrial Average fell about 50% to the 6000s level in May 2009. 

As the stock market was falling, the Federal Reserve began its massive quantitative easing program in December 2008, "printing" new money and pumping it into the banking system, from which it went into the stock market. The P/E ratio fell below 24 again in December 2008. 

Since then, the Fed has lowered interest rates almost to zero, and there is talk of negative interest rates, which are already the policy in several other countries, with little effect. ( "11-Mar-16 World View -- In desperation move, European Central Bank further lowers negative interest rates") 

If you listen to CNBC or Bloomberg TV, as I do for as long as I can stand it, all they talk about is interest rates set by the Fed and other central banks. No one seriously believes any more that the stock market has any relation to the real economy. As long as the Fed pumps money into the stock market, it will go up; if the Fed stops, then it will go down. 

The reason that stock valuations are surging is because earnings (the denominator of the P/E ratio) are plummeting. During the first quarter, earnings have declined 8.9%, with the result that the P/E ratio is pushed up. 

The stock market bubble is getting larger and larger, and there's going to be a lot of political pressure for the Fed to pump it even larger, especially from the Obama administration in an election year. But there is no bubble in history that hasn't burst, and this one is no exception. The amount of pain that it will cause will be enormous. Factset Earnings Insight (PDF)

DYI