The S&P 500 gained 27% in 2021, and yet most US stocks are cheaper today than they were a year ago.
Sure, prices are up, as anyone who has reviewed their year-end 401(k) statement knows. Valuations, however, are down considerably. The S&P 500 began 2021 with a price-to-earnings ratio of 30.7, based on earnings reported in the previous 12 months. It ended the year with a trailing P/E of 23.6.
By that measure, stocks began this year 23% less expensive even after the exceptional 12-month performance.
If that sounds contradictory, allow us to simplify: The "e" in the stock market's P/E ratio grew faster than the "p." Collectively, corporate earnings for S&P 500 companies increased 65% in 2021, well above the 27% gain for the index.
The numbers, of course, need to be considered in context. Since 1989, the average year-end P/E ratio for the S&P 500 is 19.6, according to data compiled by Charlie Bilello at Compound Capital Advisors. Current valuations, in other words, represent a 20% premium to the 33-year average while at the same time looking like a bargain relative to January 2021.
Perhaps then the real question is this: Which number is more relevant?
Some argue the longer-term average encapsulates a wider variety of economic conditions. Others suggest an ocean's worth of central bank liquidity has rendered the majority of that history obsolete, or at least different enough to disqualify it as an appropriate reference point.
It's certainly true that historically loose monetary policy by the Federal Reserve has skewed what most investors consider to be a "fair valuation." It seems logical, at least in hindsight, that a historically high dosage of Fed-induced stimulus would lead to historically high stock valuations, which is exactly what happened. The 30.7 P/E from one year ago was the highest in this 33-year sample.