I cringe when I hear someone on Wall Street say that the market is cheap based on forward P/E (price-earnings ratio). Unfortunately, profit margin cycles change (revert back to trend) and those lofty earnings estimates get revised lower, making forward P/E a poor valuation tool. I came across this chart this week. Note where forward P/E was in October 2007 (15.2) and where it is today (15.6).
Warren Buffett observed in a 2001 Fortune interview that Stock Market Capitalization as a Percentage of Nominal GDP is “probably the best single measure of where valuations stand at any given moment.” Source: Ned Davis Research
Can the equity market go higher? Sure it can, though risk is quite high. Tread carefully with your stock exposure. Up exposure to tactical strategies and allocate to equity funds that incorporate some form of downside “tail risk” loss protection.
For more about P/E and other current market indicators see my recent Forbes article Stock Market’s High P/E Suggests Lower Returns Ahead. For the latest on tactical investing strategies see our LinkedIn Tactical Investing Showcase Page.