Given the current post-pandemic uncertainties facing financial markets it is worth taking a longer-term view of the relationship between equity prices and earnings – as measured by the price/earnings ratio (P/E) and earnings growth. Going back more than 20 years we see a similar pattern at critical junctures of P/E highs, or elevated equity valuations, concurrent with falling earnings growth - seemingly irreconcilable - followed by declines in equity prices. This occurred in 2000 and 2008, coinciding with the tech and housing bubbles, respectively. This time around, we again see record high P/Es along with negative earnings growth suggesting that equities are overvalued.
Notwithstanding the differences between the current exogenously-driven pandemic shock to the economic/financial system and the earlier endogenous structural shocks, we again face a more risky environment going forward. Equity prices thus appear vulnerable at these levels.
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