Do Current Valuation Levels Suggest an Upcoming Correction?

June 19, 2015

Over the past few years, investors have become concerned about higher equity valuations and the potential for another pullback or crash. The U.S. equity market is currently in its third-longest bull market dating back to WWII, increasing worries that the run may be coming to an end soon.

This week’s chart examines modern valuations for the S&P 500 to give us a snapshot of where the equity markets are relative to the last 35 years of market data. Using the trailing 12-month P/E ratio, we see that historical valuations are somewhat normally distributed, with the mean falling between 16x and 18x earnings. As of June 18th, the P/E ratio was at 18.75, with its range highlighted in red on the chart. Though this is above average historical valuations, it is still far below the high end of the spectrum that we saw during the tech bubble.

This does not necessarily mean there will not be a crash sometime soon since many factors other than valuations can affect the market. In the second half of 2007 leading up to the recession, valuations were within the mean bar of 16x–18x, yet the index collapsed due to earnings falling dramatically after the housing crash. Though the potential for a pullback is ever-present, a significant correction based solely on valuations seems unlikely.