**Stocks Are Way Down. They’re Still Expensive.**
**The S&P 500 still has plenty of room to fall, if history is any guide**
**By Karen Langley, The Wall Street Journal, May 14, 2022**
**U.S. stocks are off to their worst start to a year in more than a half-century. By some measures, they still look expensive.**
**Wall Street often uses the ratio of a company’s share price to its earnings as a measuring stick for whether a stock appears cheap or pricey. By that metric, the market as a whole had been unusually expensive for much of the past two years, a period when especially easy monetary policy turbocharged the popular view that low interest rates gave investors few alternatives to stocks....**
**The market turbulence has drawn comparisons to the bursting of the dot-com bubble in 2000...Companies this earnings season have been mentioning variations of “weak demand” at the highest rate since 2020... The rise in 2022 profit estimates for the S&P 500 is largely attributable to brightening expectations for the energy sector. Without the sector, which accounts for less than 5% of the S&P 500, expectations for the index’s earnings this year would have edged lower from the end of last year...** [end quote]
The Cyclically Adjusted P/E Ratio (CAPE Ratio), which is the Price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years, has started to fall from its bubble peak, but it is still above the 1929 peak.
As the Federal Reserve continues to raise (“normalize”) interest rates, this peak will return to normal. Which is a lot lower than it is now.
The WSJ article has an interesting chart showing P/E ration on the X axis and stock price performance YTD on the Z axis. Although there’s a lot of scatter, there’s a clear trend. High P/E stocks have fallen much more than low P/E stocks. In the upper left-hand corner (the cheapest stocks which have risen in price this year) are ConocoPhillips, Chevron, Lockheed Martin and Kraft Heinz. In the lower right hand corner (the most expensive stocks which have fallen hard this year) are Netflix, Amazon, Etsy and Tesla.
This trend has lots of legs. The Fed’s moves have only just begun.