One of the limitations of Price to Earnings (P/E) Ratios is the volatility of earnings from year to year, particularly in a recession. The combination of reverse leverage, where earnings fall faster than revenues, and write-offs can cause P/E ratios to actually expand in down markets. There are several approaches to normalizing earnings to make the P/E ratio more meaningful. One that I like to use is the Price to Peak Earnings Ratio. This was made popular by investment manager John Hussman. Other approaches to normalizing earnings include looking at Price to 10-Year Average Earnings, which is used by Yale Economist Robert Schiller.
Currently, the Price/(Peak Earnings) ratio is 11.65. To me, it looks like the general market is neither markedly under or overvalued based on this indicator. As always, these indicators should be taken with a “grain of salt” – they all have their limitations. One factor that currently favors stocks is the level of interest rates, which were higher at previous bear market lows. Ultimately, stocks must compete for the yield available from competing assets. Currently CD’s, High Yield Money Market Accounts, and Treasuries offer very little yield.
Here is a link to my data. I will also add a link to the data on the blog’s main page.