As a follow up to our more comprehensive 2017 paper and 2018 paper, this paper will strictly focus on the historical and current relationship between the S&P 500 P/E Ratio and US Interest Rates, updated to November 2022.
The P/E ratio can be described as the ratio between current share price and per-share earnings. Earnings in the S&P 500 are calculated using the 12-month earnings per share of “current” earnings. A higher P/E ratio suggests that investors expect higher earnings growth in the future.
During the period January 1971 to November 2022, the S&P 500 P/E ratio averaged 19.9x, while the median S&P 500 P/E ratio was 18.3x. The S&P 500 P/E ratio as of November 16, 2022 was 20.6x, which is slightly higher than the historical average of 19.9x. This ratio is currently in the 62nd percentile of the historical distribution.
It is important to understand that returns can be estimated as changes in the P/E ratio and changes in earnings; therefore, factors that drive changes in the P/E ratio will also drive stock returns.
P/E ratios have demonstrated an inverse relationship to interest rates. Given recent interest rate hikes and expectations for the Federal Reserve to continue to increase rates, at least in the short-term, P/E ratios are likely to decline.
However, only 22.4% of the variability in P/E ratios can be explained by the regression with interest rates, where interest rates (i) are the independent variable and P/E ratios are the dependent variable.
When we test the current federal funds rate of 3.83%, our equation predicts an S&P 500 P/E ratio of 21.5x – very close to the current P/E ratio.
 Based on monthly data from multpl.com.
 July 2022 through November 2022 P/E ratios are estimates.
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FOUNDER AND PRESIDENT
Marty Hanan is the founder and President of ValueScope, Inc., a valuation and financial advisory firm that specializes in valuing assets and businesses and in helping business owners in business transactions and estate planning. Mr. Hanan is a Chartered Financial Analyst and has a B.S. Electrical Engineering from the University of Illinois and an MBA from Loyola University of Chicago.
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