Saturday, September 26, 2009

Equity Market Est Tres Expensif

Equity Market Est Tres Expensif

By David Rosenberg | 26 September 2009
Chief Economist And Strategist, 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 expansion of eight multiple points from the low over a mere 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" [[ie, the stuff we need to report to the IRS or land in the clinker: normxxx]] has soared 60 points since March to 184x. Which is 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, especially if you've been "bailed out"!). 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 mean total return, thereafter, on the S&P 500 a year out, is -0.3% and the median is -6.2%. And that total return is negative 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 a double from the most recent four-quarter trend. Not only that, but the current 'top-down' (analysts') estimates on operating EPS, are $48.00 for 2009; $52.60 for 2010; $62.50 for 2011; and $81.00 for 2012. The 'bottoms-up' (analysts') consensus forecasts only go to 2010 and even for this usually bullish bunch operating EPS is seen at only $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 usually overly optimistic consensus does not see for another two to three years. 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, a mere six months after record 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

• 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.

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