Why valuations don’t drive stocks

Or like we mentioned earlier, take the opposite extreme when P/Es rose above 30. The first time this occurred was 1994. Despite this P/E ratio’s unprecedented heights, it came in the middle of a long-running bull market. The second time: 1999, a great year for stocks before the early-2000s’ bear market commenced. The third time P/Es snuck above 30 was 2021—another nicely positive year for markets. Those getting cold feet then would have missed out. The lesson for investors: High P/E markets can always go higher and low ones lower. Valuations don’t tell you where stocks will go next, unlike the popular financial press Fisher Investments Australia reviews would have you believe.

Indeed, valuations can’t tell you stocks’ direction because they are backward looking and well-known. If investors follow stock valuations splashed on every financial website’s market data pages, whilst headlines blare any interesting statistic or trivia about them, then they probably hold little to no advantage. Any alleged market-moving insight is already priced in, as valuations are old news.

The late days of the 2007 – 2009 bear market are particularly instructive here, according to Fisher Investments Australia’s review of this period. Early in the downturn, P/Es slipped below average and even sub-15—decade-low levels. But that signal was based on past earnings, which markets already reflected. So when P/Es spiked as the recession destroyed earnings—hitting just below 30 in December 2009—that didn’t spook stocks. It was the beginning of a new bull market. Which raises another point: Both the P and the E in the metric can change and move. A high price relative to earnings may simply signal a company’s profit outlook is strong! That isn’t bearish.

Whilst Fisher Investments Australia’s review of stocks finds their assessment of future earnings is key (especially around 3 to 30 months ahead), what matters isn’t their absolute level or direction, but whether they miss or exceed prevailing views—what markets already priced. That is, stocks move mostly on surprise: the gap between reality and expectations. P/Es and similar metrics have nothing to say about future earnings’ surprise potential, which is why valuations aren’t predictive.