Investors have no shortage of reasons to feel panicky at the moment: war, soaring inflation, rising interest rates, the spectre of recession. All those factors have combined to drive down stocks worldwide. The question is, are markets close to a bottom, or as some bearish analysts are predicting, are we still only part way there?
One valuation metric being watched closely is the forward price-to-earnings ratios for the major indexes, which reflect their price divided by the forecasted earnings over the next 12 months of their constituent companies. The forward P/E ratios for the S&P/TSX Composite Index, the S&P 500 and the Nasdaq have all fallen sharply, to the point they are now at least back in line with their 20-year average.
By that measure the S&P/TSX Composite Index even looks cheap. As of May 19, Canada’s benchmark index was down nearly 10 per cent from its peak, trading at a forward P/E of 12.4 versus its two-decade average of 16.1.
None of this means markets can’t fall further still. Stocks could overshoot on the way down. More troubling, the past week has seen a number of companies downgrade their forecasts because of the weakening economy, which means forward P/E ratios could be sending misleading signals about market valuations.
Decoder is a weekly feature that unpacks an important economic chart.
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Jason Kirby