In the last two posts, I examined the fundamental basis for earnings of the US stock market. In this post, I will look at pricing and to what extent the market is discounting any of the risks highlighted.
Given that we have been looking at earnings already, all we need to get to the index price is to multiply by the Price-Earnings (PE) ratio from the chart below.
It is clear from the chart that PE ratios have been rising as confidence in the durability of profit growth has cemented. The current pricing levels are such, that even if earnings do return to record levels in late 2021, we would still have a PE ratio at the highs of the last decade.
This suggests that far from pricing any risk that NIPA data might be correct, or that the earnings drop might resemble previous recessions, the market is currently fully pricing a return to record profitability and excellent growth in profitability to continue from there.
I would rate stock market optimism as extremely high.