Stock Market P/E Ratios Drop, Aiding Bull Market

Bloomberg: Price-Earnings Ratios on U.S. Stocks Drop, Aiding Bull Market


There was an interesting article on Bloomberg.com (article here) yesterday detailing one theory on why the stock market could be set to post significant additional gains. This is one story I have heard from multiple pundits and advisors.

The story goes like this: This bull market (from the bottom in late 2002 through today) has seen earnings increase faster than stock prices. Thus the market multiple (P/E ratio of the market as a whole) has decreased, which is not typical for a bull market. Usually, during a bull market, enthusiasm increases faster than earnings, and thus the market multiple increases, until it gets to a level that is unsustainable, and the market turns into a bear market.

I have no idea if this will play out as advertised. What I do know is that the stock market is no longer cheap, as it has been for most of the past 4 years. Thus the inclination would be to reduce exposure to stocks in your asset allocations. However, bonds are truly pitiful right now (long-term interest rates have nowhere to go but up, so the best a buy-and-hold bond investor can achieve will be the coupon, which is lower than cash or short-term yields), so I would recommend that most people stay fairly heavily weighted in stocks, and start to add to their cash (or short-term) position.