Are Stocks Cheap?
Not really — but how “not cheap” depends upon how you measure earnings and handle one time write downs.
First up: NDR:
“Ned Davis Research looked at market valuations after bear markets since 1929. The firm found that in the first three months after bear markets, the market’s P/E tends to climb by about 10 percent. And the multiple has traditionally expanded 22 percent in the first six months after a major market downturn.
But since March 9, when the recent rally began, the P/E of the S.& P. 500 has jumped nearly 40 percent. Such a surge in P/E ratios may be warranted if the recession ends soon and profits recover quickly. While there are some signs that the worst of the recession may be behind us, few analysts expect profits to stage a major rebound. And, of course, it’s still unclear whether the recession and the bear market have ended.”
The article also notes, however, that stocks are not terribly cheap ex-one time write-downs. If we look at just operating earnings — excluding one-time write-offs — the P/E of the S&P500 is 22, hardly bargain priced.
NDR also looks at P/E in an interesting way — instead of just adding up all the SPX earnings them dividing into price, they assess each individual stock P/E ratio. Then, they find the median P/E for the group — the midpoint, with 250 stock P/Es above and 250 stock P/Es below.
The result? The median P/E of the S.& P. 500 is 15.6 — well above the median P/E of 12 in March, but below the market’s historical median of 16.5.
>
Sources:
This Rally May Need a New Source of Fuel
PAUL J. LIM
NYT, June 13, 2009
http://www.nytimes.com/2009/06/14/your-money/stocks-and-bonds/14fund.html
June 14th, 2009 at 1:47 pm
The 130 current P/E for GAAP (as reported) earnings may be largely due to “one-time writeoffs”, but operating earnings are forever ignoring inconvenient stuff such as options expenses. (BTW, the GAAP P/E will be over 1000 next qtr). The closest apples to apples comparison for a long period (say 1925) is to use as reported earnings. Even if you buy the “one-time writeoff” argument, you still have to explain why the P/E is 130, when the highest it has ever been (height of tech mania) was 45. If these are one-time items, not uncommon in history and not a major problem, we would have seen similar P/Es before…yet nothing remotely close. Finally, S&P estimates that, even with the market flat for the next year, accounting for a recovery in earnings, the P/E will be 28.
To summarize – unless the S&P has greatly underestimated the earnings rebound, you could hold the S&P500 for the next year and if you are lucky enough to break even on it, you will still be holding an investment at twice its 85 year median valuation. I wish you well with that.
http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS?GXHC_gx_session_id_=5350992f205e73e4&
June 14th, 2009 at 1:51 pm
Money quote: “And, of course, it’s still unclear whether the recession and the bear market have ended.”
It’s wonderful to know that people devote so much time and effort to develop ingenious ways to convince themselves and others to ignore their lying eyes.
You’ve got to Ac-Cent-Tchu-Ate the Positive (which requires eliminating the negative)
http://www.youtube.com/watch?v=Z45EB4TiYz4
June 14th, 2009 at 2:03 pm
with all this talk of “Medians”, it’s hiliarous that Tao Jonesing, above, references a lyric whose next line is:”Stay away from Mr. In-Between”..
Past that, his point,and SB’s, are ones I concur with. This ‘Market’ gives an, entirely, new meaning to “Paint by Numbers”..
June 14th, 2009 at 2:32 pm
Since stock valuations are based on many many years of future earnings, one or two years of scant earnings — if caused by a temporary condition like a recession — should not drastically affect stock valuations. This is why Robert Shiller uses normalized trailing earnings averaged over the previous 10-years. Based on 10-year normalized earnings, the Price to Normalized Earnings ratio today is right around the historical average, making stocks neither substantially overvalued nor undervalued.
June 14th, 2009 at 2:35 pm
“Such a surge in P/E ratios may be warranted if the recession ends soon and profits recover quickly.”
As John Hussman has shown, profit margins pre-crash were at historical highs. I’m not sure that we should expect the recovery to take us back to historical highs (although, with all of the government subsidies, it’s entirely possible that the effect could be recreated at the expense of the taxpayer).
Why doesn’t anyone do the normalized P/E ratios based on mid-cycle ROE times current book? Is it just too difficult/time-consuming to do something like this for a broad index?
Also, why do we always want to compare current P/Es with a long term historical P/E. It’s extremely likely that this data series is NOT stationary.
June 14th, 2009 at 3:00 pm
sorry, something was sticking about that last post, on 2x-checking, http://www.lyricsdepot.com/johnny-mercer/accentuate-the-positive.html
“Don’t Mess with Mister In-Between”
~~
although, now, I will say that it’s too bad that that hoary PE10 concept was trotted out–as a likely Favorite in the Stakes, instead of a Candidate for the Glue Factory.
matt’s take: “…data series NOT stationary.” is, much more, likely to Win this Derby.
June 14th, 2009 at 3:19 pm
I’m reading The Only Three Questions That Count by Ken Fisher. He claims that his analysis shows that P/E is completely uncorrelated with market performance. That is, the old rule that low P/E is a buy signal and high P/E is a sell signal is just wrong.
I’ve just started the book, so I can’t yet say if he seems to know what he is talking about. Has anyone read the book or know if Ken Fisher is a reliable source?
~~~
BR: At FusionIQ, our back-testing has determined the same thing — P/E is over rated
June 14th, 2009 at 4:04 pm
[...] “Are stocks cheap? Not really — but how “not cheap” depends upon how you measure earnings and handle one time write downs.” (Big Picture) [...]
June 14th, 2009 at 4:35 pm
@Steve Barry
You go Steve!
Quite appropriate that you were the first post to this thread…
I have nothing to add here other than to say I’m 100% in agreement with SB…I’d say 110%, or 1000%, but it unnerves me the people who toss out percentages like that to UNDERLINE 100% just about as much as it UNNERVES a certain polulation of bloggers here that I use the effing CAPS LOCK as much as I do
…
Sorry, couldn’t resist…
Anyway, I’m just doing a quick “drive-by” here…there are a lot of threads to catch up with…
It’s hard to do because my hands are all bloody from cutting down 2 trees on my property in WVA this weekend…Actually I didn’t cut them down so much as I trimmed them…This is the property I got 6 months ago…There is one monstrosity of an ugly tree that ISN’T EVEN ON MY PROPERTY (but it’s borderline between my property line and the easement)…Damn thing is uglier than shit (some “mongoloid” version of a honey locust)…I’d called Allegheny Power months ago to tell them that it was looking kind of dicey and they’d better come out and remove it (or it would threaten the power lines)…
So they come out (this was 3 months ago)…”Naw, it’s OK” they say…So 3 weeks ago a huge wind and electrical storm weakens a main lateral trunk on the thing and its falling all into my yard, yet still attached (I mean, we’re talking probabaly a ton and a half of lumber now occupying 1,000+ sq ft, of my yard that I still need to detach, but doing so involves a MASSIVE weight crash)…So I call them again and say…”See I told you so” (and it’s WORSE now because the ton and a half weight displacement from that trunk made the rest of the tree lurch onto a cable and telephone line, connected to the power line above)…If that thing goes, it’s going to take down 2 telephone poles…They come out again, and STILL do nothing…
About a week goes by and I don’t even know if I can touch the thing with my chain saw…I mean, if it pulls any harder on the trunk line from between the telephone poles, I might get 10,000 volts of electricity shot up my ass…
Finally, I said “F-it”…So Sat & Sun I dismantled the MF’er…Good news is that I’ll get about a cord of firewood out of it come autmn once I chop it it bitty pieces…
I celebrated by cleaning the pool
…(More refreshing than you can imagine after the first half of the operation (which tore my hands to shreds – but at least I didn’t lose any limbs, or toes, in the process, or ELECTROCUTE myself)…
So what does this have to do with whether or not STOCKS ARE CHEAP…Nothing!…But at least my mind was off the subject for about 30 hours…And SB kept everyone “in the know” in the process…
@Thor
In another thread, you gave everyone an anecdote as to what was happening in Palm Springs this weekend…My anecdote, is that (notwithstanding myself), there was plenty of “recreatin” in the region of Harper’s Ferry WVA…It took me 40 minutes to pass through the single lane stretch on I-340 from Bolivar Heights (on the WV side), through the Shenendoah River bridge pass, and subsequent Potomac River bridge pass on towards Antietam/Frederick…But one has to understand…floating down the river rapids on the Shenandoah in an inner tube (and they were out in FORCE), doesn’t cost that much and is a TON OF FUN…
June 14th, 2009 at 5:45 pm
Replying to Dave J:
Ken Fisher demonstrated only that P/E does not predict stock market returns over the next 12 months.
John Hussman proved that P/E does have predictive value over a 10-year horizon. A high normalized or smoothed P/E predicts subpar stock returns over the following 10 years. A low normalized P/E predicts above average returns over the next 10 years. At present, Hussman sees normalized P/E as moderately high and therefore sees the expected returns in the stock market of only around positive 4 to 6 percent per year when compounded over the next 10 years. In other words, a 10-year Treasury that yields 4 percent, if bought today, should do as well as the stock over the next 10 years.
June 14th, 2009 at 6:08 pm
The fact of the matter is everyone likes to talk about P/E as some kind of import metric. Important for what? We are living in an emo world today. Not indie. The big dogs can afford to be emo once in a while. Their wage slaves save them on a regular basis. The little guys get erased acting on emo which lots of WS likes to see.
In retrospect, I can’t think of a single person that invests on P/E.
Future prospects. How else would IPOs have a chance? Except they’re kind of dogfood too. Emo.
I would say that there’s a risk premium currently assigned to NYSE, NASDAQ, by the SMARTS. And the only others playing are the computers looking for volatility.
June 14th, 2009 at 6:50 pm
One point I wanted to make but forgot was that once we “recover” I can’t forsee earnings power returning to what it once was, which was tanatmount to alchemy, especially in financials and housing which leaked out to everything.
June 14th, 2009 at 6:53 pm
seneca,
Hussman’s smoothed P/E does seem to have some predictive power over long term. However, it showed the market overvalued, but stocks still rallied for 2 1/2 years. Now I see where he’s fudging his model because of the record profit margins of 2007. Debt is a miracle worker eh? Anyway, it looks like our historic debt binge has fubared a lot of things. Hopefully one casualty will be the bogus FED model.
June 14th, 2009 at 6:56 pm
Thanks Alfred…
Would that be alfred as in “batman’s butler”
or…
Alfred E. Newman (what me worry?)…
Because the best I can do to is to try and figure out how over a century of “benchmarking” using price to earnings ratios by managers handling billions of trillions in aggregate just got reduced to an “emo vs. indie” argument in 4 short paragraphs…
When you reply, please don’t be CRUEL…Remember that I’m just the arrogant unabomber so I’m miles behind the black boxes…
June 14th, 2009 at 6:57 pm
…part deux (@alfred)
So for now I’m sticking with SB’s logic
June 14th, 2009 at 7:15 pm
@cvienne: I would prefer to be Batman’s butler. Or Scottie. As in “Beam us up Scottie” .
Unfortunately, my pleasure is in adopting the Alfred E. Newman perspective “What, Me Worry?”
Except if I were Alfred I would be on a beach somewhere totally removed from this blog.
I’m still working on it. Avoidance. Important things to say. If it’s not a video game or an iPod app, forget it.
Lived in MD once upon a time: Potomac. Made it to Harper’s Ferry. Interesting choice.
It’s all too crazy. Even there.
June 14th, 2009 at 7:29 pm
@cvienne: BTW. The untold truth. the Unabomber was an incredibly caring, brilliant person. Read the Mainfesto, but use the term “progressive” instead.
June 14th, 2009 at 8:04 pm
@alfred
LOL
Thanks for being a sport there my friend…
AVOIDANCE isn’t an altogether BAD way to approach things these days…
Hell, I’ll admit firsthand…The fact that I spent the last 30 hours sawing two tons of the “antichrist” version of a honey locust into SNICKERS BARS doesn’t mean that I’m a “God fearing industrialist”…Instead, it means…I’D TAKE ANY DISTRACTION…ANY WHATSOEVER…TO KEEP MY EFFING MIND OFF OF DAILY NEWS FLOWS…
Although I think the Shenendoah “tubers” did a better job than me…Bless their souls…
Unabomber?…Don’t know much about the guy (not that you do either)…I’m vaguely recollecting here… but it seems to me that I was living in Italy (1993 – 2005), during the time that his antics essentially hit the MSM and were eventually brought to a conclusion…
So to put it all into perspective…(per comments I read last week, combined with my ‘chores’ of recent days)…I’m more likely to ED GEIN ( the inspiration behind the Texas Chainsaw Massacre), rather than Kasinsky (at least in my opinion)…
…but BTW…I “torched’ the teeth on my chainsaw this weekend bringing down that honey locust…Next week I not only need them to get replaced, but I’d probably better order a spare chain…
So all of you TBP bloggers are SAFE & SOUND for the time being…& if you think my CAPS LOCKS pre-condition a visit to you whilst you slumber…ur safe for the time being…
…and karen, just after I’d struggled 30 hours with the honey locust lumber…I was dexterous enough to don a pair of scissors and snip off a hearty snatch of arugula leaves…
…rinse…pinch of salt…paint of olive oil…fresh grated parmesian…
LUNCH
June 14th, 2009 at 8:51 pm
@cvienne: Cougar alert.
June 14th, 2009 at 11:05 pm
To quote Dr. Hussman’s weekly comment tonight:
“Valuation Update: We estimate that the S&P 500 is currently priced to deliver total returns over the next decade in the range of 6.5-9.0%, centered at an expected total return of about 7.8% annually. Stocks are modestly overvalued here, except on metrics that assume a permanent recovery to 2007’s record profit margins (which were about 50% above the historical norm). ”
More here:
http://www.hussmanfunds.com/wmc/wmc090615.htm
A very good read tonight.
June 14th, 2009 at 11:13 pm
Another good quote from the article:
“Investors shouldn’t kid themselves that stocks are cheap – in the sense of being priced to deliver outstanding long-term returns – just because we’ve observed a wicked decline. We’re not even close.
At the March lows, the S&P 500 was priced to deliver long-term returns in the 10-12% range. Certainly not bad, but only modestly above the norm on a historical basis, in an economy that faced (and still threatens to suffer) difficulties well outside the norm. While that might have been the final low, and we can’t rule out further market gains, I still believe that it is a mistake to rule out eventual “revulsion.” I don’t think that we need to match valuations that existed at the 1974 or 1982 lows, but at a multiple of 16 times our current estimate for normalized earnings, suffice it to say that the market is not cheap.”
June 14th, 2009 at 11:46 pm
Re: Ken Fisher. I won’t pretend to be expert on all his work, and I know that he’s a long time Wall Streeter that earned a pretty good rep for performance during the bull market of the ’80s-’90s. But for me he completely discredited himself with his rationalizations in the latter days of the market highs re: valuations, etc., and with regard to the myth that savings rates didn’t matter because of asset appreciation.
I’m inclined to believe he’s just another guy who looked like a genius during the great bull run, but has been exposed since then as being less than such. So I’d take what he says with a big dose of skepticism.
June 15th, 2009 at 5:35 am
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