David Rosenberg: Equity market est tres expensif
The stock market assessment below comes from highly regarded David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates.
The S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings and history shows that at these high valuation levels, the market declines in the coming year 60% of the time.
All we know is that we have a trailing P/E multiple (operating earnings) on the S&P 500 of 26.5x – a record eight multiple point expansion from the low over a six-month span. Take note that this is the highest P/E multiple since March 2002, which is right around the time that the bear market rally at that time (also premised on post-crisis V-shaped recovery hopes) began to roll over. It took a good year for the fundamental bottom in the market to be put in, and that was heresy back then too. The P/E multiple on non-scrubbed reported earnings has soared 60 points since March to 184x – not only a record but five times more expensive than what we saw during the peak of the dotcom bubble a decade ago (oh, but we forgot – write-downs don’t matter).
Going back over the last six decades, we know that the market typically faces serious valuation constraints once it breaches the 25x P/E multiple threshold. The average total return a year out for the S&P 500 is -0.3% and the median is -6.2%. The total return is negative a year later 60% of the time, so when we say that there is too much growth and too much risk embedded in the equity market right now, we like to think that we have history on our side.
As for valuation, well let’s consider that from our lens, the S&P 500 is now priced for $83 in operating EPS (we come to that conclusion by backing out the earnings yield that would match the current inflation-adjusted Baa corporate bond yield). That is nearly double from the most recent four-quarter trend. Not only that, but the top-down estimates on operating EPS, for 2009 are $48.00 for 2009; $52.60 for 2010; $62.50 for 2011; and $81.00 for 2012.
How does the U.S. macro landscape look like when the markets rally 60% from the low?
The bottom-up consensus forecasts only go to 2010 and even for this usually bullish bunch operating EPS is seen at $73 for 2010, which means that $83 is likely a 2012 story according to them. Either way, the market is basically discounting an earnings stream that even the consensus does not see for another two to three years. In other words, this is more than just a fully priced market at this point.
The S&P 500 is, in fact, deeply overvalued at this juncture. Imagine that six months after the depressed lows we have a situation where …
• The trailing price-earnings ratio on operating EPS is 26.5x.
• The trailing price-earnings ratio on reported EPS is 184.2x.
• The price-to-dividend ratio is 53x, where it was at the 2007 highs. Again, the market is trading as if it were at a peak for the cycle, not any longer near a trough.
• The price-to-book ratio is 2.3x. If you want undervalued, try August 1982 – the onset of an 18-year secular bull market – when the S&P 500 bottomed after trading at a discount to book value.
Source: David Rosenberg, Gluskin Sheff & Associates – Breakfast with Dave, September 21, 2009.
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