November 22, 2014

Market P/E Still Inexpensive Given Tax And Inflation Context; +10% To 25% U.S. Equities Upside Remains


Summary

  • The U.S.’ current market earnings multiple of 18x is commonly seen as expensive when compared to the 15x-17x historical average.
  • Investors need to consider the effect of the tax and inflation environments on the markets.
  • During prior periods with similar tax and inflation environments, the market P/E ranged from 20x to 22x – indicating more upside still for the U.S.

With the S&P 500 above 2,000, some analysts and investors see the market as expensive, citing how the current market P/E of about 18x exceeds the long-term average of 15x-17x. However, those long-term averages include periods of time that look nothing like today. Comparing current market levels to long-term averages can be decidedly out of context. Compare this market to a more relevant set of historical data and U.S. equities still look inexpensive.

To get such low historical averages of 15x, one needs to include periods of time like the 1970s when investors’ taxes were at historically high levels and inflation ran as high as 7% and above. Take out those periods, and you see a very different picture. Over the last 100+ years, when U.S. equity investors experienced comparably low inflation and low investor taxes as today, market P/Es settled comfortably in 20x to 22x ranges.


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