American Consequences - February 2019

EDITORS John Gillin

Greg Diamond C. Scott Garliss

Remember, analysts have recently slashed estimates for the S&P 500. They’re worried about China-U.S. trade negotiations... and they’re worried that a breakdown in the talks could have negative implications for growth. If that’s the case, estimates are likely headed lower and the market will look expensive once more. However, if the opposite winds up being true, this record-long bull market could still have room to run...

While there are many factors, one important factor to keep an eye on is valuation. In particular, we like to use the price-to-earnings (P/E) ratio to gauge where we think the S&P 500 is headed... For anyone unfamiliar, P/E is used to measure a stock price relative to its estimated earnings. Remember, earnings potential is a constantly moving target. In other words, as companies update metrics or the news cycle changes, estimated earnings move, too. As a result, we need to keep an eye on which direction the S&P 500’s P/E moves. A rising P/E might indicate an overvalued stock or asset, whereas a falling P/E might indicate a low price relative to future earnings. By monitoring this variable based on history, you can have a better idea of when to buy and when to sell... increasing your potential gains. For example, based on estimated forward 12-month earnings of $168.16, the S&P 500’s 5*VEXMSMW4ZIVXLIPEWXǻZI]IEVW EGGSVHMRKXSHEXEVIWIEVGLǻVQ+EGXIXXLI S&P’s average P/E ratio is 16.4 times. That means based on history, we could be getting close to a market top or a correction. Now, it doesn’t mean we can’t go above 16.4, but you can at least get an idea of fair value.

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