SPX Earnings & Multiples ?
There's an interesting article in today's WSJ in which (coincidentally), I have a brief quote in:
"The financial system is undergoing a sea change that is forcing a global sell-down of assets. Even when this is complete, there is likely to be greater restraint when it comes to the use of borrowed money to juice returns. At the same time, investors are likely to demand a far higher price to take on risk than in the past. Even if financial stocks feel the brunt of these changes, few, if any, industries will be unaffected.
That argues for prices that reflect reduced expectations of future profits. Yet consensus estimates peg 2009 aggregate operating earnings for companies in the Standard & Poor's 500-stock index at about $94 a share, according to Thomson Reuters. That figure assumes earnings growth both this year and next.
If those estimates panned out, the S&P on Friday would have traded at what looks like a bargain multiple of about 9.3 times forward earnings. Shift earnings to the lower end of the consensus range, about $75 a share, and the multiple rises to 11.7 times.
That still might seem cheap compared with multiples that often exceeded 20 times during the 1990s. But it is well above trough valuations of about eight times seen during the depths of the 1970s bear market, according to data from UBS. And the economic outlook, along with the unwinding of the credit bubble, means it is unlikely that earnings will increase this year or next. The better question is how far they will fall.
Bears are well below the consensus in their answer. Barry Ritholtz, director of research at Fusion IQ, for example, says he reckons that 2009 earnings could drop to about $50 a share. In that case, even a multiple of 14 times would bring the S&P to about 750 -- nearly 15% below current levels."
Good stuff . . .
Source:
Autumn Is Here. Now for the Fall...
DAVID REILLY
WSJ, OCTOBER 25, 2008
http://online.wsj.com/article/SB122488013725867611.html
Saturday, October 25, 2008 | 12:04 PM | Permalink
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Barry,
If you feel the market is 15% overvalued, then why have you turned bullish recently? I do see that the market is trading at a historic low price to book. Granted, "book" may be as questionable as the earnings.
Are you buying dips despite valuation?
Posted by: ss | Oct 25, 2008 12:18:07 PM
Barry:
Just noticed this posted by Hussman on Thursday. Won't quote the whole thing, but here's the part not just related to the fund. The stats at the end about P/E are interesting. Of course I have no independent verification, but Hussman, et al, are good with nerd stuff like that:
"While we allow for further market weakness, investors should also allow for a potential market rally in the 20-25% range (toward 1100 on the S&P 500). Even in 1973-74, the S&P 500 halted its decline at 48%. In 1929, the initial decline also halted at 48% (followed by an advance of nearly 50% over the next 6 months before weakening again). Even if this bear market is headed toward a P/E of 7, a single decline, uncorrected by a major rally, is unlikely. Bill Hester also observes that historical bear markets ending at single-digit price/peak-earnings multiples also generally started at multiples about 10 or less (with the exception of 1973-74 when earnings actually grew to new highs as stocks fell). We can't rule out further weakness of perhaps 10-12% in the major indices but do not anticipate it."
Posted by: Mike in NOLa | Oct 25, 2008 12:18:20 PM
Ken Fisher was on Fox yesterday saying how cheap stocks were not so much based on earnings multiples, but relative to long-term interest rates (something he's been saying since S&P 1500). Three points: First, I don't recall him saying clearly what he thought earnings on the S&P 500 would be this year or next. That's telling. Second, Howard Simons has mentioned several times the problems caused by comparing earnings yields to Treasury rates when the latter is considered a *refuge* from the former, not simply an alternative. Third, the most glaring shortcoming of Fisher's commentary over the past 12 months has been an examination of why he's been so wrong. Specifically, he believed that a housing collapse couldn't happen because too many people were already worried about it. Given that the theory underlying so much of his investing ("they are worried, so I don't have to be") has been shattered, it seriously calls into question the foundations of his whole approach. (By the way, I think Fisher is guilty of a lot of the same things as Greenspan. They both trusted "self-interested" capitalist CEOs far too much, i.e. "You don't need to regulate. You don't need to worry about it so much. These hard-nosed businessmen will take care of it in the marketplace.")
Posted by: Eric | Oct 25, 2008 12:20:59 PM
And if my information is correct a multiple of 14-16 times is the Historical Average. In bear Markets (think 73-74, 00-02) multiples can drop to the single digits (7-9)...
I think 50-60 dollars a share Trailing 12 months (or reported actual earnings) is probably a good estimate.
However, that gives the S&P 500 another Sizable Haircut...
See links here:
http://comstockfunds.com/files/NLPP00000%5C293.pdf
and here: (scroll to bottom and click this link: S&P 500 Historical Average Price to Earnings Ratio):
http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_500/2,3,2,2,0,0,0,0,0,0,5,0,0,0,0,0.html
Posted by: John | Oct 25, 2008 12:31:46 PM
It is my understanding that cash currently on the sideline is worth about 50% of the S&P 500 market cap. This is several standard deviations from even past lows. I wonder how much HF liquidation is left to go. Any thoughts on this Barry?
Posted by: ss | Oct 25, 2008 12:42:27 PM
"Barry,
If you feel the market is 15% overvalued, then why have you turned bullish recently? I do see that the market is trading at a historic low price to book. Granted, "book" may be as questionable as the earnings.
Are you buying dips despite valuation?"
I'm wondering the same thing?
Posted by: Owner Earnings | Oct 25, 2008 12:43:39 PM
Wait, I'm missing something here.
Aren't stocks valued based on discounted future earnings, regardless of time frame? So, if earnings went away completely for the next two years (but expectation was to return) stocks would not take a 100% haircut, would they? If this is the case then I don't see the linear relationship between PE multiple and stock valuation.
Posted by: Ivan | Oct 25, 2008 12:44:29 PM
There are numerous stocks trading at very healthy valuations, many of the mining and energy stocks are notable in this regard, however that is because they're still reporting record earnings, those are likely to drop going forward. But at PEs of 4-6 on many large players - teck cominco was down 15% in pre market yesterday which I took advantage of after being down continusouly in previous days and having just reported fantastic earnings. Ganett is trading at at a ridiculous level regardless of how much you think newspapers are obsolete, and yes they're still making money to pay that fat dividend. There is lots of value trading at 4-7 time earnings, solid companies, low debt, and selling things that people need. Healthcare may be a bubble but sny and gsk are reasonably valued at these levels with nice dividends while you wait it out. Even carnival cruise lines is getting to nice evaluation levels. There are utilities trading at 7 times earnings with power purchase agreements into 2020. Nasdaq is another story but even msft reaching reasonable valuations for a tech stock.
Posted by: chris in canada | Oct 25, 2008 1:01:59 PM
It may still be overvalued in relation to current earnings/book/dividends, that doesn't take away from its potential future value.
It also doesn't take away from the potential of a rather severe sudden rally, which would be a great trade.
Posted by: Jason | Oct 25, 2008 1:09:24 PM
Those who are asking why Barry is short term bullish should read the excerpt from Hussman. I'm sure Barry has more sophisticated reasons than that, but you may get an idea.
Posted by: Mike in NOLa | Oct 25, 2008 1:11:51 PM
ss @ 12:18:07 PM
Not necessarily a contradiction.
As is so often the case, it all depends on one’s time frame.
Posted by: DL | Oct 25, 2008 1:12:10 PM
OOps.. My Bad. P/E ratios Did Not get down to the single digits in the 00-02 Bear Market. They stayed Elevated-- in the upper teens to near 20.
Heres a (rather Rough) chart of the 1929 crash Mike in Nola was discussing above in regard to Hussman and the likli-hood of an upcoming Retracement:
http://www.lowrisk.com/crash/1929crash3.htm
Notwithstanding Barry's 10+ good points a week or so ago about why we may be in for a Trading Bounce/Bottom I think the Historical Perspective of the 1929 Bear Market, the 73-74 Bear Market, and the 2000-2002 Bear Market is that they all took Well Over 12 months to Form 'The Bottom'-- Giving Investors/Traders Plenty of Time to get in. Given the sheer Magnitude of the Problems/Issues Responsible for this Bear Market (12 or so months now from the Market Peak in Oct. '07), the fact that the Stock Markets and Real Estate Markets are directly linked, the fact that (on a Historical Basis) it has taken anywhere from 3-5 years for prior Housing Recessions to form a Bottom, it is anyone's guess (outside of advertising and ratings) why some of these Pundits on CNBS, Bloomberg, et al. continue to Harp about 'The Bottom' being near.
And Notwithstanding my prior post above The question I have with some of todays commonly used indicators such as the VIX, Put Call Ratio(s), etc. is that we are now trying to apply them to Markets that are linked Globally (linked in large part by the Credit Derivatives Market--some 60+ Trillion Dollars worth).
I don't know that many of these technical indicators and data points hold the water they once did...
However, if some of the Fans of Elliot Wave Analysis are out there (Andy Taboo) it would be interesting to see where we are with that. If I recall some Folks were looking for one more Hard Push to the Downside... before we get a Relief Rally.
Posted by: John | Oct 25, 2008 1:16:55 PM
This graph is illustrative (S&P vs S&P P/E)
http://tal.marketgauge.com/dvMGPro/charts/Charts.asp?chart=PERATI
it would be nicer if it went back further but historically it still shows the s&p as expensive. Nevertheless it also shows that that the s&p p/e was not a determiner of the 2003-2007 rally. People mention that the 70s held lower market P/Es - it also held higher interest rates. Barry likes indexes, I prefer individual stocks because then I can weed out the crap, the only banks I'd buy are the cdn banks and USB with TD being my top cdn choice, when I buy the index I have to buy all the other crap in there. A lot of the income trusts hit very nice levels, some are also too small for any fund to invest in but for small fries you can get involved - tjere are advantages to being a retail investor.
Posted by: chris in canada | Oct 25, 2008 1:23:49 PM
pro/con, buy/sell, Bull/Bear, that's all fine, but noone is discussing 'Currency Risk'...
that's, hardly, a "Black Swan", either..
all this talk of E, in P/E, or E, in A=L+E, and noone cares to wonder whether tomorrow's E will be = to today's E?
curious..
Posted by: Mark E Hoffer | Oct 25, 2008 1:35:56 PM
I have enjoyed reading this blog for some time but have not joined in because I feel very much less qualified than the regular contributors. However, because this issue is THE issue for both traders and investors I hesistantly offer what little I have gained from 37 years trading the markets. I trust you all will correct my errors.
1) multiples are primarily a function of (a) long term interest rates and (b) expected earnings growth. In my view, earnings growth will be weak for a number of years; and, if the world doesn't end, then interest rates will begin to rise (possibly significantly) within the next year. Therefore, multiples will remain relatively low.
2) S&P companies likely to have high relaive earnings (e.g., Exxon, Microsoft and so on) have had relatively low multiples even in the last bull market. So it is not total S&P earnings that matter to me but the distribution of earnings. If Barry is right about $50 S&P earnings, how many companies will account for, say, 50% of that total and are they growth companies?
3) Whatever the market low will be -- it will not come before mid 2009 -- it will lead on to fairly desultory trading range market. I am interested in trying to "guesstimate" that trading range. Picking a low is folly.
4) Who will be the buyers? For all the commentary about hedge funds and mutual funds as the determinative, marginal buyer and seller, the dominant buyers over the past 25 years have been corporations and retirement funds. My view of the future does not include continuation of large-scale, corporate share buy-backs or M&A activity. Secondly, even if retirement funds are not eviscerated by this bear market, they face a long-term future of payouts to retirees dominating cash infusions. good luck.
Posted by: Mac E. Avelli | Oct 25, 2008 1:40:48 PM
Barry Ritholtz, director of research at Fusion IQ, for example, says he reckons that 2009 earnings could drop to about $50 a share. In that case, even a multiple of 14 times would bring the S&P to about 750 -- nearly 15% below current levels."
BR: Are you referring to the operating earnings that David Reilly is referencing in the article or to reported earnings? My guess would be the latter, but if not, could you clarify? [Chart for reference here with S&P's recorded and projected earnings data for both.]
Quick aside: Regarding the possibility of a bottom forming in the S&P 500, isn't it funny how we can both get to the same place using such different methodologies? [Link is to David Templeton who links to both of us!]
Posted by: Ironman | Oct 25, 2008 1:42:59 PM
Just b/c Barry is bullish here, doesn't mean he believes this is "the" bottom. It is turning into a great trading entry point, regardless of a person's long-term view point.
I really don't get how people can't understand a short and long term view... It's really not that hard of a concept
Posted by: JasRas | Oct 25, 2008 1:45:12 PM
Among the deflationist websites I often hear energy stocks mentioned as a place with value. Even the deflationist Mish, sights energy as one of the few areas that doesn't have rampant oversupply.
In considering these companies one needs to consider the price of oil relative to the increase in the USD. From my perspective as a canadian, the CADUSD was around parity in July when oil was at around 140, now the CADUSD is at .785 and oil is at 65, but for a candian oil company oil that's the same as 82 bucks with the dollar at parity, they can still make a killing at those levels, and I'm talking traditional not expensive oil sand plays.
When the dollar heads south again it will support the price of oil, same thing happening with gold. In these respects the fall in oil is not as much as everyone says it is, likewise for gold, that is if at least if you're not living in the US but you got all kinds of things the US needs. Heck if I was american and I was stepping in long I'd be taking advantage of the strong USD and stepping into select cdn companies who have gotten trashed, the usd may have room to go but we at some point our resources, budget surpluses, conservative banks and federal minority governments (meaning that nothing gets done - eg no gov't meddling) will count for something.
Posted by: chris in canada | Oct 25, 2008 1:46:13 PM
One does not make investment decisions in a vacuum. All assets are owned on a relative basis to other assets. Currently, the ten year treasury yields under 4%. Multiples on stocks could contract to 7-10 range but how likely is that with an alternative of 4%?
If treasury yields rise substantially, multiples will probably contract further. At these levels, it is not likely.
Stocks and other riskier assets like corporate bonds are worth the risk at these levels.
Posted by: Mike M | Oct 25, 2008 1:48:42 PM
It is my understanding that cash currently on the sideline is worth about 50% of the S&P 500 market cap. This is several standard deviations from even past lows. I wonder how much HF liquidation is left to go. Any thoughts on this Barry?
-----------------------------
Wait until governments around the world start issuing more bonds for all the promises they've been making. Bond yields will soar and money will be flowing into those, not stocks!
Posted by: DANM | Oct 25, 2008 2:00:29 PM
http://www.telegraph.co.uk/finance/3248452/Calpers-suffers-50bn-fall-in-pension-fund-assets.html
Are pensions pulling out of hedge funds? Is this what is causing the spike in the dollar and the fall of foreign equities and currencies as hedge funds liquidate assets to pay off bailing investors?
If so, where does that money go once it is out?
Posted by: Blackhalo | Oct 25, 2008 2:12:29 PM
Here's a nice post from Barry in Jan,2006.
Thanks again BR for all you do! This site has been invaluable to me.
Once again, it's all about sentiment which I don't see turning around anytime soon. This will hold P/E's at the low end.
P/E Expansion and Contraction
Monday, January 02, 2006 | 11:37 AM
in Investing | Markets | Psychology/Sentiment
Last week, I showed a 50 year chart of the S&P500, focusing on the P/E over that time period. Today's chart covers the same issue, only we focus on the 1982-2000 Bull market.
Some people argue that P/E expansion wasn't all that significant; they say it was (if anything) a function of falling interest rates. In my mind, that only partially explains why multiples expand; It certainly cannot rationalize why P/Es went from 7 to nearly 50 over the course of ~20 years.
Why might the median P/E have run from 7 to 32 during the Bull market?
My explanation is Psychology: something shifted in investor sentiment that made them willing to pay more than $7 for a $1 of earnings -- much more. That change is best explained by a sentiment shift related to perceived relative Value.
>
Most investors do not think P/E expansion as the lion's share of the market's 82-2000 gains; Instead, they credit a robust economy, technological advances, productivity gains, and (of course!) earnings improvement.
And all those elements did have an obvious impact -- by my math, they were responsible for about 25% of the performance.
But the biggest contribution these four elements had was not to the bottom line; rather, it was to investor psyches that gradually became willing to spend more per dollar of earnings than they had been. They allowed a rationalization of higher prices: Aren't stocks worth more if the economy is doing well? Doesn't technology make companies more efficient with their capital? If workers are more productive, went the thinking, than earnings will be all the more better.
Notice how squishy these thoughts are; they may be rational, but they are hardly the sort of easily quantifiable data points that makes for a dispassionate, calculating investor.
Link including the graph:
http://bigpicture.typepad.com/comments/2006/01/pe_expansion_an.html
Posted by: bobbyside | Oct 25, 2008 2:16:15 PM
The market has not priced in that there will be no market as we know it. It's way worse than the 70's. Maybe even the 30's.
Unlike anytime in history, we now have more banks, companies, and whole insolvent sectors of the economy now directly propped up by the government. And indirectly, the market itself. That always ends up well.
You can’t even say the market has priced in the full effect of a deep U or L shaped recession not seen since the Depression. The whole world knew those earnings last week would stink, but apparently the market reaction was the equivalent of shocked surprise. What’s next?
The idea of stocks as a retirement vehicle is being completely undone. There is a cultural change in this regard that is happening after the worst losses of “wealth” in history. The market has not even begun to price in that the pool of buyers and demand is going to be a mere fraction of what it was.
We have, for the first time in history, the possibility of not funding our national debt, which approaching 100% of GDP (not since WWII)-- except through printing. So to add a cherry on top, the intrinsic premium of US stocks valued in the world's reserve currency is drawing to a close.
A lot of historical firsts into uncharted waters. I'd say a stock price equals sentimental value plus the present value of all expected dividends. Dividends in the next 3-5 years you say....?
Posted by: MethodMan | Oct 25, 2008 2:18:22 PM
I obviously can't speak for BR, but you people wondering how BR can both buy and make such a comment to the media seem to be really missing the point. BR didn't go in whole hog; he didn't draw a line in the sand. He reasoned that we've reached the point where an investor **PROBABLY** won't get burned too badly with an entry at S&P 900s. But at the same time, we could go a fair bit lower. Scaling in? Ever hear of it?
Posted by: Eric | Oct 25, 2008 2:27:29 PM
For all the commentary about hedge funds and mutual funds as the determinative, marginal buyer and seller, the dominant buyers over the past 25 years have been corporations and retirement funds. My view of the future does not include continuation of large-scale, corporate share buy-backs or M&A activity. Secondly, even if retirement funds are not eviscerated by this bear market, they face a long-term future of payouts to retirees dominating cash infusions. good luck.
------------------------
Another way of looking at stock prices is to add up all future discounted cash flows. Of course the price will be very different if you discount using a risk free rate of 3.5% or 6%.
Using my assumptions, stocks have been overvalued for a very long time.
Then you could argue about the liquidity premium, blah, blah blah... I could just argue that half the market is not calculating anything. These investors say to themselves: "Wow, I like Google, everybody loves Google. Google is a good business so Google has to go up. It's all about supply and demand and demand is strong!"
On this basis, I would argue that a significant % of this liquidity premium in multiples comes from all these investors who do not sit down and do the math. And these investors have penalized even the pros. Why? Because the pros who've done the numbers know the multiples are too high but they still have to be fully invested, so they've resorted to comparing one stock vs.the other even if fundamentally the whole market is too expensive.
You try explaining that to the average Joe who's been forced to take care of his own portfolio because his company has canned the DB and converted to DC. Yup, we've forced average Joes to plan for their retirement without any formal education in financial markets. That is deplorable.
So now who will be the future buyers now that people will be paying down debt, never mind investing. As the economy slows and jobs are lost, many more investors will be forced to raid they pension accounts before admitting defeat.
If that was not enough, you're going to start getting Boomers retiring and selling their investments to pay for their retirement. In Canada, most RRSPs (401K equivalent?) are emptied within the first few years of retirmenet. And for every retiring Boomer who takes out 20K, you need 4 Gen-X saving 5K. Good luck because even in the good years, the average contribution was something like 3K.
So you won't be seeing much new money hit the markets, there is a lot of money on the sidelines but a huge chunk of it won't be going into stocks.
My guess is that a lot of that money will be taken out to buy bread over the next couple of years but investors don't know it yet.
Posted by: DANM | Oct 25, 2008 2:32:05 PM
