Fun With Charts!

When you hear the phrase ‘the market is rich,’ it refers to the stock market having a high P/E ratio. A P/E ratio is a stock’s price divided by its earnings over the past 12 months. Thus, if the share price of a stock is $100, and the annual earnings for that stock are $10, the P/E ratio is 100/10 = 10. 
Stock valuations matter. The chart below¹ shows the correlation between P/E ratios and future returns. Notice, for example, what happens to stock prices when P/E ratios peak. Over succeeding years, stock prices often go down. They’ll eventually bottom, rise, and peak again. (As the chart shows, these cycles recur over and over, for various lengths of time.) 
As shown on the graph, the term P/E fwd (forward) is the price of the S&P 500 Index divided by its projected earnings over the next 12 months.   

  
The chart below² shows the 30-year average forward P/E ratio is 17.1, while the chart above shows the forward P/E ratio as of 1/31/2026 was 22.0. Seeing that, your first reaction might be to sell everything and head for cash. 

Yes, we’re heading towards a peak, or may even be near a peak, but we don’t know where the top is. And selling too early may mean ‘leaving money on the table.’ Rather than randomly picking peaks and valleys, we address record-setting stock prices by rebalancing and building up the fixed-income sides of portfolios. But that’s not new news; you already know that.

One caveat worth noting about current stock valuations. There is a significant concentration of mega-cap technology stocks within the S&P 500, and tech stocks often have higher P/E ratios because they tend to grow faster. 

We’ve witnessed outsize valuations by formerly dominant companies in the past (e.g., GE, IBM, General Motors), and we’ve also seen those once-great companies lose their leadership positions. While some may argue “This time it’s different,” we’ve also heard those words uttered far too many times.

The takeaway from high P/E ratios is to temper your expectations for market returns over the next few years as the cycle plays out. Yes, the average return of the S&P 500 may be approximately 10% over the past 100 or so years, but history also shows it’s never a smooth ride.
 

1 “S&P 500 index at inflection points,” Slide 4, Guide to the Markets, J.P. Morgan.  Jan 31, 2026.  

2 “S&P 500 valuation measures,” Slide 5, Guide to the Markets, J.P. Morgan.  Jan 31, 2026.

S.F. Ehrlich Associates, Inc. (“SFE”) is a registered investment advisory firm in New Jersey that offers investment advisory, financial planning, and consulting services to its clients, who generally include individuals, high net worth individuals, and their affiliated trusts and estates. Additional disclosures, including a description of our services, fees, and other helpful information, can be found in our Form ADV Part 2, which is available upon request or on the SEC's website at www.adviserinfo.sec.gov/firm/summary/121356.

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