Stock Market Volatility Is Increasing. Valuations Matter.

US Market are getting more volatile. Tariffs have certainly been part of it, but what we have been focusing on with our clients are equity valuations. 

This is a chart form JPMorgan that we share with our clients, and it shows the forward Price-to-Earnings ratio of the S&P 500. P/E ratios are one way to measure valuations. Simply put, it measure the price an investor pays for a dollar of underlying earnings. 

As you can see, the 30 year average is 16.9. Prior to the beginning of this correction, the forward P/E was about 22, well above the average, and well above 1 standard deviation. This indicates to us that markets are overvalued. 

Historically, when markets are overvalued this much, we see corrections in the magnitude of 20%-30%.

Now, no one can time the market. We don't know when the correction might happen. Historically, they don't just happen on their own. Generally, there is a catalyst that triggers the correction. In the past its been the Fed changing monetary policy, or a slow down of the economy and corporate earnings, or a black swan event, such as COVID or the collapse of Lehman Brothers. Tariffs could be that catalyst. Tariffs could certainly slowdown economic growth and corporate earnings. 

A couple things to focus on going forward.
1. Know how you're invested and how much volatility to expect. If you can't answer this, then you have some work to do. 

2. Be patient, and wait for a buying opportunity. If the markets continue to correct, and valuations get more attactive, it's a good time to invest.