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Posts Tagged ‘S&P500’

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):

Four bad bears 91509

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.

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