The stock market’s price-earnings (P/E) ratio is high relative to its long-run average leading some strategists to argue that either prices will soon fall or returns will be low over the next several years.
But if you consider the price-earnings ratio in the context of the currently low inflation rate, prices could arguably go higher.
“Low inflation tends to support larger price-to-earnings ratios, as the lack of price pressure facilitates easy monetary policy which encourages multiples expansion,” said Guggenheim Partners’ Scott Minerd in his weekly commentary. “Though the P/E ratio of the S&P500 has been on an upward trend in recent years, historical ranges suggest there is further room for expansion due to low inflation. With inflation expected to remain below the Fed’s target through 2015, the P/E ratio could rise as far as 24X and still remain within historical norms.”
Of course, this assumes inflation stays low. Some indicators, like medical care prices, have been turning up recently.