Chart of the Day - S&P 500 PE Ratio 12/10/2010

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The chart of the day below, illustrating the historical PE Ratio of the S&P 500, may be fuel for the bulls out there looking for the market to move higher in 2011.

What I would be cautious of however for anyone relying on this alone, is that I've noticed several companies lowering earnings guidance for 2011. If this is the case, what will be the effect on next year's PE Ratio?

Today's chart illustrates how the recent rise in earnings as well as the recent stock market correction has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio).

Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive.

From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s).

As a result of the recent spike in corporate earnings, however, the PE ratio currently resides at a level not often seen over the past two decades.

Chart courtesy of Chart of the Day
Chart of the Day S&P 500 PE Ratio 12/10/2010



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