Peak PE ratios often happen at the bottom of a crash, not before a crash. Don’t forget about the E.

I see a lot of people on this sub treat PE ratios as though they are only affected by price. They say things like “PEs have come down enough that things might be a good buy.” But what they are really saying is that prices have come down enough that PE ratios look reasonable if we assume this earnings environment persists. But in times of economic contraction, current earnings environments often don't persist.

In 2000, the top of the market came in August of 2000 (around 1500 for S&P). Average PE was 28. By March 2002, the S&P had dropped to 1100, yet PEs had spiked to 46. In fact, when the bottom of the market came in September 2002 (around 800 for S&P), average PEs stood at 27 — slightly higher than PEs had been before 45%+ came off prices.

In 2008, the top of the market came in October 2007 (also around 1500 for S&P….same as 2000). Average PE was 23. By June 2009, the S&P had dropped to 900, yet PEs had skyrocketed to over 120! When the bottom of the market came in February 2009 (around 730 for S&P, also similar to 2000), PEs were over 100.

Think about this: In 2008, 51% came off the S&P, yet PEs went up from 23 to 100+. This is the power that decreasing earnings can have on PE ratios.

Major recessions and market crashes feature plummeting corporate earnings. This causes PE ratios to increase, so the mere fact that PEs have decreased shouldn't provide solace to you if we are entering a time of slowing economic activity and shrinking corporate earnings. You have to answer that “if” before you can begin to assess whether prices are reasonable.