A P/E ratio rising from 10 to 18.35 is what happens when the S&P 500 rallies 50% (the P) while earnings (E) continue to decline. Below we provide a chart of the S&P 500 price to earnings ratio since the start of the 2002 bull market using trailing 12-month diluted earnings per share from continuing operations.
The S&P's P/E ratio reached its highest level since the end of 2004 earlier this week. While P/E expansion is not unusual during bull markets, investors will remember that the S&P 500's P/E actually declined from the start to the finish of the '02-'07 bull. This is because earnings grew even faster than stock prices. When looking at the chart below, you can see that the P/E did expand in the early days of the '02-'07 bull before earnings finally started to grow again in late 2003 and early 2004. Obviously if the current bull is going to have any sustainability at all, earnings will have to start growing again. But for now, as evidenced by the skyrocketing P/E ratio, investors are paying up on the hopes of future earnings growth.
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