We’re struggling to find value in this market. We’ve got a handful of interesting plays on the watch screen, but we don’t want to overpay and they don’t seem to come down, so we’re stuck. In the last two days alone, the stocks in our watch screen are up an average of 9.6%, when we want each to come down between 10-15% (or more). It’s frustrating, and it’s prompted us to wonder if the market is getting a little expensive.
The S&P500 is now up 56% from its March 9 low. That’s a big rally, but as this dshort.com chart demonstrates, big bear market rallies are not unusual (click chart to enlarge):
Hans Wagner of Trading Online Markets has an excellent analysis of the S&P500 P/E ratio today. According to the article, the historical P/E ratio for the S&P500 has a median of 15.7. Today, it stands at 139, which seems – ahem – quite high. Why so high?
Even with the recovery in the markets since the lows in March, the S&P 500 PE ratio remains very high as the trailing four quarters of earnings is so low. According to data from Standard & Poor’s on the S&P 500, as reported earnings for 99% of all reporting companies, creates an S&P 500 PE ratio of 122.41 as of June 30, 2009. The trailing four quarters of earnings was $7.51. Two years ago the as reported earnings for the S&P 500 companies was $84.92 for the quarter ending on June 30, 2007. The S&P 500 PE ratio was 17.70. This plunge in earnings is what caused the S&P 500 PE ratio to rise so high.
So is the market going higher? Hans has some interesting thoughts:
Using the December 2009 quarter the earnings forecast $39.35 and a PE ratio of 30 gives us a target price for the S&P 500 index of 1,181. On Friday September 11, 2009, the S&P closed at 1,044. A PE ratio of 25 gives us an S&P 500 index of 984. If the S&P 500 PE ratio remains between 25 and 30, we should see the S&P 500 index climb to a range of 1,146 to 1,375.
This examination of earnings and S&P PE ratios is telling us to expect a higher S&P 500 index throughout 2009, as long as the PE ratio remains in the 25-30 range. Whether this is correct, depends on several factors. First, are the earnings forecast correct? Investors should monitor earnings expectations throughout the year, looking for any changes either up or down. The estimates for all of 2010 are higher now than they were in June, indicating S&P is expecting a more robust recovery.
Time to crack out the Santana Champagne? Maybe not:
Yale University Professor Robert J. Shiller, author of Irrational Exuberance: Second Edition uses a modified PE ratio that smoothes out the volatility in the ratio. The denominator of this modified ratio is average inflation-adjusted earnings over the trailing 10 years. Shiller calls this modified ratio “p/e10.” Using this data the modified ratio “p/e10” produces a PE ratio of slightly over 15, which is very close to the median of 15.7. In December 2007, the beginning of the current recession, the “p/e 10” was 25.95. Since markets tend to cycle above and below the median, we should expect the “p/e 10” to fall further before turning back up.
Using December 2009 trailing four-quarter earnings of $39.95 times the median PE ratio of 15.7 gives us an S&P 500 index of 627. This gives us a range for the S&P index of a high of 1,375 assuming an S&P PE ratio of 30 to a low of 675 with a PE ratio of 15.7, the median.
And in sublime understatement:
The risk is to the down side.
So, if forecast earnings of $39.35 materialize and the S&P 500 P/E ratio remains between 25 and 30, we should see the S&P 500 index between 1,146 to 1,375. If, on the other hand, we use the median P/E ratio of 15.7, the S&P 500 index sinks to 627 – lower than the March 9 low of 666.79.
When might we return to the bear? We don’t know, but we like a contrary indicator. Yesterday Ben Bernanke called the U.S. recession “very likely over.” With the high priest of finance going long, we think it might be time to ring the bell and call the top. We want to hear what you think. Are we there yet, or is the market going higher? Nail your colors to the mast and place your bets in the comments before the close today. We need a closing price, a date and a reason. We’re taking 1,052.63 and September 15, 2009 based on our Bernanke Indicator. The winner gets the adulation of Greenbackd readers and the inaugural Greenbackd Gizzard-Squeezer Gong.
1175 by December 31st. Why? My guess is Q4 economic numbers will blow by Street expectations and drive up global markets. Working in the hedge fund industry I still get a sense many of my peers are underinvested so they will be chasing returns into the end of Q4.
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S&P 1,200 by year end. Then the trillions in stimulus and 0% rates runs out and economic reality has to set in. It is going to be about impossible for new highs in the indices because the last couple decades has been pure fantasy. So I guess I’d lean more to a sell-off after we get near previous highs, if we can. This economy can’t sustain higher oil prices and flat or declining home prices. It will need a strong consumer to. Don’t see how this is possible long-term.
A currency crisis in future to.
ADPT is right over NCAV and the activist is getting busier
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Thanks, Mark. ADPT is one on the watch screen. We’d prefer it at $3.00, but instead it’s run 15% in two weeks.
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Ill say the S&P will be 15% higher. The higher ups in the the US Government have declared the recession over. This should give investors enough confidence to come back into stocks. This alone should drive up prices.
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OK, but only because you asked nicely.
I’ll give the S&P a 50% retracement of its peak-to-trough decline, which would take it to 1121. That’s about 5% from here. I’ll give it 2 weeks to get there, September 30.
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The image below perhaps provides appropriate context to Bernanke’s recent statement:
http://valueinvestingresource.blogspot.com/2009/06/1927-1933-chart-of-pompous.html
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re: Mr. Bernanke’s opinion as a possible contrary indicator:
“We believe that short-term forecasts of stock or bond prices are useless. The forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” – Berkshire Hathaway, 1980
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Surely will get plenty of datapoints on various crowd emotions, etc.
I’d argue, amounts largely to a context of coin-flippers… with enough recorded tosses and guesses, eventually someone will ends up with the correct sequence [of forward ROE & EPS, capitalized at the proper Multiple] by pure luck.
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Greenback’d is founded on Ben Graham — so at the very core:
“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” – Benjamin Graham, The Intelligent Investor (Fourth Revised Edition, page 287)
– Annon
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Arguably, there’s two angles: the “EPS” and the “Multiple”
Yes, possible the “Multiple” declines — re: PE/10, or even… re: inflation itself (…would the market trade at 15-20x, in a high inflation world?)
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What’s interesting as well is to explore the “EPS” side, which, arguably, would be a function of ROE.
Circa 2008, ROE for the index was roughly 18%. Longer term, norm seems to be somewhere in a 12-15% ballpark.
Mr. Buffett’s comments from 1977 provide an interesting Latticework:
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Must we really view that 12 percent equity coupon as immutable? Is there any law that says the corporate return on equity capital cannot adjust itself upward in response to a permanently higher average rate of inflation?
There is no such law, of course. On the other hand, corporate America cannot increase earnings by desire or decree. To raise that return on equity, corporations would need at least one of the following: (1) an increase in turnover, i.e., in the ratio between sales and total assets employed in the business; (2) cheaper leverage; (3) more leverage; (4) lower income taxes, (5) wider operating margins on sales.
And that’s it. There simply are no other ways to increase returns on common equity.
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Meaning, what could be interesting is to back-into the EPS and PE assumptions needed to justify various forward looking projected market levels.
i.e., to suggest “1201″ is to say X multiple on Y earnings. And, that Y earnings… — and would be able to infer the implied level of ROE needed to hit the forward EPS estimate.
So, question really becomes: Line-by-Line, will the following be “more” or “less” – circa 2013 vs. circa 2008
(1) turnover
(2) cost of leverage;
(3) amount leverage;
(4) income taxes level,
(5) operating margins
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The real issue becomes, what happens if:
a) Multiple reverts back to a low teen / high single digit range, while
b) Earnings power reverts to a mid-teen ROE range vs. high teen ROE range?
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Maybe things are a bit frothy at moment
– There’s virtually *no* companies hitting a 52 week low in recent trading.
– Suggesting that there’s hope and greed driving prices, rather than fundamental conditions.
– Surely there’s some companies that should be worth even less today than the mark-to-markets in March?!
Bottom line, markets can remain irrational longer than an individual can remain solvent.
So, no problem just taking a pass. Maybe miss a rally. Maybe miss a bull market. Perfectly fine.
Will, in due time, find something worth swinging at.
[Especially if, in 3-5 years, the ROE of the US Economy is closer to 12-14%vand the multiple is (somehow) at a mid-teen range.]
– Annon
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I’ll take Nov 15 and 1421. This is my hedge against the reality that we ought to be at 600.
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I am hesitant to do this because I don’t want to create a subconscious bias that influences my investments but….. my lucky penny tells me we’ll get a quick spike to 1249 as the final bears capitulate when we have an up Sep rather than a down one, Oct 9, then we get crushed in a trade war/dollar crash/inflation/lack of growth death spiral….
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Here are a couple links to help people guess a little better:
S&P Earnings:
http://www2.standardandpoors.com/spf/xls/index/SP500_EPS_DIV_20090911.XLS
More on p/e10
http://dshort.com/articles/2009/SP-Composite-pe-ratios.html
I’ll say 1320, 12/15/09
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S&P 500 at 880 by Feb 1 — because Jeremy Grantham says that’s fair value.
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Market timing is impossible. If there are no cheap stocks then there are no cheap stocks. But there are cheap stocks. But…. 1201 is my guess, Oct 2nd, because of Oil (????)
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