By Nick Kalivas
Mon 04 Jun 2012 10:59:57 CT
The Moody's Baa corporate yield has at times provided some guidance on the correct PE ratio for the S&P 500. The scatter chart below displays the relationship between the Moody's Baa yield and the PE ratio for the S&P 500. Notice that there is an inverse relationship between the yield and the PE ratio, but dramatic variation in the relationship. Currently, the PE ratio is on the lower bound values given the current Moody's Baa yield which is around 5.00%. The S&P 500 is trading at about 13.8 times Q2 trailing 4-quarter as reported earnings, but the scatter suggests a value close to 25 may be justified --"on average". This indicates that investors have a dim view on future profit growth or stocks are attractive. It may be some combination of both. In any case, the scatter highlights the caution toward the market, and implies stocks are cheaply priced to corporate debt. Resolution of the fiscal cliff in the U.S., and the EZ financial crisis would likely help to lift the PE ratio.
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