Markets

Forward P/E Ratios May Have a Lid on Them Due to Recent Geopolitics

March 21, 2014

2 minute read

Stock investors have learned over the years to either ignore geopolitical crises or use them as buying opportunities. It seems to me that we may need to reassess the geopolitical risks and their possibly adverse impact on stocks. Previously, I’ve shown the forward P/E of the S&P 500 on a monthly basis since Jimmy Carter was in the White House.

There are lots of valuation models, but It’s easy to see that when the US became the sole superpower during the 1980s and 1990s, the P/E trended higher. During the previous decade, the US increasingly lost some its international stature, and the P/E trended downwards. The jury is out on where we go from here now that the P/E is the highest since June 2007. It may very well depend on geopolitical factors again.

So far, the stock market doesn’t seem to be giving much if any weight to rising geopolitical risks. During the current bull market, valuations have been driven mostly by perceptions of financial risks. That’s understandable given the Trauma of 2008.

The forward P/Es of the S&P 500/400/600 rebounded dramatically at the start of the bull market as investors bet that the Fed’s ultra-easy monetary policy, FDIC guarantees for new bank debt, and the suspension of mark-to-market would end the financial crisis and revive the economy. They tumbled during the spring of 2010 as the Eurozone seemed to be heading for disintegration. They recovered over the rest of the year on hopes that wouldn’t happen.

The P/Es plunged during the summer of 2011 on renewed fears of a Eurozone meltdown and on the downgrade of US Treasury debt. Since then, the forward P/Es of the S&P 500/400/600 are up 46%, 43%, and 50% to 15.2, 17.4, and 19.2. In a melt-up scenario, they could go higher. Right now, uncertainty about Yellenomics and geopolitics might put a lid on them.

Today's Morning Briefing: Yellenomics & Geopolitics. (1) No fairy dust yesterday. (2) FOMC participants see 1% fed funds rate at end of 2015. (3) Yellen says ignore the “dot plot.” (4) Reconsidering “considerable time.” (5) From data dependent back to calendar based? (6) Giving Yellen a D for a failure to communicate. (7) Yellen’s dashboard. (8) How’s reset working out? (9) WH freezes Putin’s account. (10) Putin’s Cold War speech. (11) Geopolitics and valuation. (12) Focus on underweight-rated S&P 500 Energy. (More for subscribers.)