When I last brought you an earnings season update we were just shy of the halfway mark, with 227 of the S&P 500 companies having already reported earnings. Nearly 90% of S&P 500 companies have now reported.

Three weeks and 216 earnings reports later, much has changed.

Most notably, stock prices are now at a 10-year high. I like to measure the valuation of a stock, sector and even entire markets using the price-to-earnings (P/E) and forward P/E ratios.

The forward P/E ratio of the S&P 500 is now 17.1, the highest it has been since 2004. The chart below comes from FactSet’s weekly earnings insight report and illustrates the change in the forward P/E ratio over the past 15 years.

2.23.15 SP500 Forward PE Ratio

Not only does the S&P 500’s valuation sit at a 10-year high, you can see that it is also well above the 5-year, 10-year and 15-year averages.

Does this chart suggest that the market is expensive? The short answer is that relative to historical benchmarks, yes, the market appears to be expensive. But it isn’t quite that simple.

It is important to understand the forward P/E ratio and what might affect it.

The forward P/E ratio is simply the current price divided by forecasted earnings. As such, a rising forward P/E ratio can be the result of rising stock prices, falling earnings estimates or a combination of the two.

In this case, both have occurred.

The forward P/E ratio of the S&P 500 was 16.2 at the start of 2015. Since then, the market has risen 1.9% and earnings estimates have fallen 3.3%. Alone, either of these factors would have sent the forward P/E ratio marginally higher. Together, these factors have sent the forward P/E ratio all the way up to 17.1, an increase of 5.6%.

That means that, in just under two months, the stock market has become 5.6% more expensive when measured using the forward P/E.

Considering that 2015 earnings forecasts call for record-breaking S&P 500 earnings, it seems clear that the high forward P/E ratio is the result of high stock prices and cannot be explained away by the slightly lowered earnings expectations.

There are still some major earnings announcements left in this earnings season. Target (NYSE: TGT), Home Depot (NYSE: HD) and Lowe’s (NYSE: LOW) all report this week. The chart below shows the strong earnings growth reported by other retailers so far this earnings season, suggesting that results from these best-in-class companies could boost earnings expectations for 2015.

2.23.15 Retail Earnings Growth FactSet

Certainly strong numbers from a number of companies including these major retailers could raise the S&P 500 earnings estimates and bring the forward P/E down. This would result in more reasonable stock valuations for the S&P 500.

While we remain positive on many individual stocks and investment themes, the takeaway here is that the S&P 500 appears to be expensive relative to historical valuation metrics. I’m of the mind that cheap oil is here to stay for at least a few quarters. This will be a huge negative for the energy industry but a huge positive for several consumer-dependent industries.

That said, this data suggests that we should keep our expectations in check.

With dividends reinvested, the S&P 500 returned 14% in 2014, 32.4% in 2013 and 16% in 2012. Considering that growth is slowing and stock prices are notably higher than they have been in several years, investors should expect much flatter S&P 500 returns in 2015.

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Published by Wyatt Investment Research at