S&P 500 Forward P/E Ratio Rises Above 20.0 as EPS Estimates Continue to Fall

On May 7, the forward 12-month P/E ratio for the S&P 500 was 20.4, which marked the sixth time in the past seven trading days in which the P/E ratio for the index was above 20.0. How does this 20.4 P/E ratio compare to historical averages? What is driving the recent increase in the P/E ratio?

The forward 12-month P/E ratio of 20.4 on May 7 was above the four most recent historical averages for the S&P 500: five-year (16.7), 10-year (15.1), 15-year (14.6), and 20-year (15.4). In fact, this past week marked the first time the forward 12-month P/E ratio had been equal to (or above) 20.0 since April 10, 2002 (20.0). However, it is important to note that even at 20.4, the forward 12-month P/E ratio was still below the peak P/E ratio of the past 20 years for the index of 23.4 recorded on September 1, 2000.

At the sector level, nine sectors had forward 12-month P/E ratios on May 7 that exceeded their 20-year averages, led by the Consumer Discretionary (36.6 vs. 17.8) sector. A forward 12-month P/E ratio for the Energy sector was not available on May 7 due to the projected loss for the sector in CY 2020 (P/E ratio was negative). A 20-year average P/E ratio is not available for the Real Estate sector.

What is driving the rise in the forward 12-month P/E ratio? On March 23, the forward 12-month P/E ratio was 13.1, as the price of the index hit its lowest value since 2016 at 2237.40. Since March 23, the price of the S&P 500 has increased by 28.8%, while the forward 12-month EPS estimate has decreased by 16.2%. Thus, the increase in the “P” and the decrease in the “E” have both been drivers of the sharp increase in the P/E ratio over the past seven weeks.

It is interesting to note that over the past 20 years, the correlation coefficient between the daily forward 12-month EPS estimate for the S&P 500 and the daily closing price of the S&P 500 is 0.92 (where 1.0 is a perfect positive linear relationship). Thus, both numbers tend to move in the same direction over time. Given the added uncertainty around estimates for future earnings due to COVID-19 (79 S&P 500 companies had withdrawn annual EPS guidance during the Q1 earnings season through April 30), this correlation may temporarily not hold. But assuming it still holds, it would seem unlikely the that the increase in the price of the index and the decrease in the expected EPS for the index will continue much longer. Will the price of the index begin to fall, or will the forward 12-month EPS estimate begin to rise?