William R. Emmons

English

Research Papers in Economics

June 1998
MonetaryTrends
The Current P/E Ratio:
Higher Than You Think
The price-to-earnings ratio (P/E) of the Standard &
Poor’s composite stock index averaged 27.76 during
April 1998, slightly exceeding the P/E of 27 observed
during January 1894.  This was the highest level
observed in any January since 1871 (see the chart,
which shows the P/E ratio observed in January from
1871 through 1998).* Yet from a business-cycle per-
spective, the U.S. stock market had already far sur-
passed all previous records for high levels of valuation.
In contrast to 1997 and 1998, virtually all previous
years with high P/E ratios were either recession years
or closely followed the end of a recession.  For exam-
ple, the market P/E reached its previous historic
January high of 27 during the relatively severe reces-
sion of January 1893 through June 1894.  The second
highest January P/E ratio was 26.2 in 1931, in the
middle of the Great Depression (August 1929-March
1933).  Other peak P/E years were 1921 and 1930,
which also were recession years, and 1992, which
followed a recession lasting from July 1990 to March
1991.  Other years with January P/E ratios over 20
include 1888, 1893, 1896, 1934, 1991 and 1998.
With the exception of 1998, all of these years
occurred either during or shortly after a recession.
High P/E ratios typically occur during or soon after
recessions because corporate earnings tend to fall more
than stock prices during recessions.  Investors rationally
expect future corporate earnings to bounce back, so they
are willing to pay a relatively high price for a given
level of current earnings as they wait for the economy
and publicly traded companies to recover.  As earnings
rise in an expansion, the P/E ratio (roughly, the price
paid for a claim on all future earnings) tends to fall.
The 1990s present an interesting contrast to this
historical pattern.  During every January of this
decade, the P/E ratio has been above the average of
13.4 experienced over 1871-1989.  More strikingly,
P/E levels reached in January 1997 and 1998 are
without historical precedent for a mature expansion.
At the current level of stock prices, a decline in cor-
porate earnings of 30 percent, as occurred in the
recessionary period 1989-91, would cause the market
P/E ratio to soar to about 40￿a level never before
seen in the U.S. stock market.  Thus, from a cyclically-
adjusted historical perspective, stock prices are
unprecedentedly high.
￿William R. Emmons
*For these and other historical data, see
www.econ.yale.edu/~shiller/chapt26.html
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
0
10
20
30
1870 1890 1910 1930 1950 1970 1990
April 1998
S&P 500 Price-Earnings Ratio (January) 
1888
1894
1893
1896
1921
1931
1930 1934
1991
1992
1998

The current P/E ratio: higher than you think

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The current P/E ratio: higher than you think

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Research Papers in Economics