From 1988 to August 15, 2007, the average trailing Price to Earnings (PE) ratio of the S&P 500 was 22.7. As of August 15, 2007, the current trailing PE ratio of the S&P 500 is 16.3.
Since we are using the years 1988 to 2007, this overweights the great bull market of 2000 including the Bubble. According to Wikipedia, the average PE ratio of US Equity from 1900 to 2005 is 14 or 16 depending on how you calculate it.
When we look at quarterly earnings (as reported), we notice that earnings from 1988 to the peak of the bubble rose 3 times. From 2003 to 2007, earnings of the S&P 500 rose 5 times!
Yet, if we look at the historical PE, the S&P 500 PE is still a very reasonable 16, and if we look at forward (estimated) PE as of August 15, when the $SPX was 1406, we notice that the S&P 500 forward PE is a low 14.75. This would suggest that the S&P 500 has room to run.
At the moment, the Fed is likely to cut rates. In a falling rate environment, PE ratios can have even more room to expand.
There are also models which look at the yield on the ten year bond to estimate the PE ratio of the S&P 500.
The Ten Year Treasury Bond Yield ($TNX. Divide $TNX by 1000 to get Yield) is currently (August 24, 2007) 4.63%. To estimate the potential PE ratio based on that, we take the reciprocal of the yield, to get 1/.0463 = 21.6.
A low inflation rate is also good for stocks.
Based on all this, the S&P 500 may have room to run to the upside.
Latest S&P 500 estimates from Standard and Poors
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