Over the last few months, there have been many market pundits that have been talking about the high historical valuation of the US stock market. The term bubble may be the most frequently occurring word used in many newsletters and chat rooms as of late other than GME. There are many ways to measure valuation in the market but the most common is the price earnings ratio (P/E). While the metric is useful as a broad snapshot for historical perspective, it is also very misleading as the price/earnings ratio is counterintuitive for multiple reasons. The P/E ratio is simply the price of a stock divided by the earnings of the company’s annual run rate of earnings. In other words a stock trading at $50 and has earnings of $4 for the current year, then the P/E ratio is 12.5. The current value of the S&P 500 is 3800 with a 2021 earnings estimate of $170 implies a P/E ratio of 22.4. This is above the high end of the historical range.

Since the onset of the pandemic, there have been many predictions about how this current crisis will play out. Many economists forecast the economic recovery with a letter such as a U or a V. In a V shaped recovery, there decline in the financial markets and the real economy but then a quick rebound back to levels before the correction or slowdown or recession. The U shaped recovery describes a decline with a bottoming out process that lasts for some time before economic conditions improve to pre crisis levels. As of late, we have been hearing about the K shaped recovery. Simply put, the phrase implies winners and losers during this time frame.