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Sound Advice: May 22, 2024

 When asked about the stock market, J.P. Morgan responded: “It will fluctuate.” And indeed it does.

One of the major influences is the level of interest rates.  When rates are rising, stocks tend to be weak.  When rates are easing, stocks tend to strengthen. 

See the chart below which shows the relationship between price-earnings ratios (valuations) and interest rates from 1880 to 2010.  The extreme case was 1981, when prevailing rates were in the mid-teens . . . and the market was in the tank.  Then as rates eased stocks regained their footing.


This ties in to the reality that even though one can calculate a normal valuation (price-earnings ratio) for the stock market, it almost always trades at a premium or discount.  Typically, the stock market will gain strength and wider valuations when business earnings are climbing and interest rates are moderating.  And vice-versa.

Depending on your source, you may learn that the normal valuation of the Standard & Poor’s 500 Index is between 16 and 18 times earnings.  But the index is rarely at a normal value.

At the time of this writing, the price-earnings ratio of the index was 24.8 times, well above the typical level considered normal.  Maintenance of this level will depend on prospective easing in interest rates and continuing advances in corporate profits.

 

N. Russell Wayne

Weston, CT

Any questions: please contact me at nrwayne@soundasset.com

203-895-8877

www.soundasset.blogspot.com

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