Stock markets

Price inflation data for May 2022 was released yesterday in the US. Over the full year to end May, the consumer price index increased by 8.6%. The AFR reports that this is the highest 1 year increase in 40 years. The stock markets reacted badly. The Dow Jones industrial average lost 2.7% and the NASDAQ lost 3.5% in value.

That stocks have been broadly overvalued is well accepted. Part of the reason supporting high valuations was low discount rates. A year ago, the average P/E ratio on stocks in the S&P500 was over 37. Today, it is 21.5. That reduction will have been largely driven by recent market sell offs and revaluations with higher discount rates as yields on debt markets increase. But 21 still looks expensive. I’m not sure I want to pay $21 to buy a future earnings stream of $1pa. With the high likelihood of further increases in discount rates plus risks to underlying earnings owing to economic malaise, the P/E ratios are under pressure both on the top line and bottom line.

I’d expect there is more red ink to come.