The S&P 500 has the lowest P/E in more than two years, are there further declines ahead?

The S&P 500 is arguably the most popular index in the stock market, with its value reflecting the share price of the 500 largest companies listed in the US. At the same time, the US enjoys the largest equity market capitalisation, standing at a whopping $53.4 trillion at the end of 2021 and accounting for more than half of all equity markets worldwide.

Exchange-traded funds (ETFs) are a popular way to invest in the S&P 500. They reflect the behaviour of the underlying asset, in this case, the mentioned index. One of the most popular is the SPDR S&P 500 ETF Trust (SPY).

Doing so ended the so-called bear market rally that started in June. The first popular indicators that pointed to the end of the rally were the RSI and the MACD. The SPY price fell shortly after the RSI signal line entered the overvaluation zone and the first downward bar of the MACD histogram was drawn. Two days ago, the MACD histogram entered the negative zone. The SPY price is below the 10, 20, 50 and 100-day moving averages.

What could be influencing the S&P 500's declines?

According to Current Market Valuation, the P/E ratio (share price/earnings per share) of the S&P 500, recently hit its lowest level in more than 2 years. The P/E is considered a relatively good measure of valuation and is around 20 for the index, 25% higher than the historical average of 16.

Its above-average level, together with worrying data from the economy, may indicate a possible continuation of their downtrend, but it is worth noting that the market seemed to ben generally 'overpriced' for several decades.

This may be due to the increasing share of technology companies in the capitalisation of the S&P 500, whose valuations are largely based on future growth. In addition, the huge capital stock in the US relative to GDP may be driving demand for equities, and thus we may have higher equity valuations.

According to the report “Stock Market Briefing: Selected P/E Ratios" by Yardeni Research (which aggregates average recommendations from Wall Street analysts), the target forecast P/E for the S&P 500 in 52 weeks (1 year) is around 16.7. Other companies report a similar forecast P/E. This may indicate the market's belief that declines might continue in the coming months.