S&P 500 Expensive… Maybe in a World Without Prospects?
Yesterday I tuned in to this country’s premier business network (it shall remain nameless) to get a feel for the week’s bullish up/down market chatter. I found myself in the middle debate whether the market (a la S&P 500) was cheap or expensive. It was the moderator Scott Wapner and the panel included guest speakers, Cameron Dawson, John Mowryand: Bryn Talkington. Only one participant was armed with a historical perspective (a detailed knowledge of inflation and rates 45 years ago). The other three were not. In the market, the crowd (the three ignorant of the facts) is always wrong.
In today’s media environment, there are legions of market analysts who would say that markets are overvalued compared to the historic lows of the late 70s and early 80s, where high rates and era inflation drove the PE down to 8x. Few explain why today’s PE should be much lower. One panelist used this period as a strong reason why the market PE should be much lower. This pessimism is a rule and not an exception for media covering the market and the economy. It’s only one of four that’s right in the clip above.
Superficial comparisons give wrong answers
One examinee who knew the 8 PE statistics didn’t dig deep enough to realize the PE was there because rates and inflation were much higher 42 years ago than they are today. We are talking about the maximum yield of the 10-year US Treasury note over 15%. That would give you the equivalent PE of that bond at 6.7 times (100 divided by 15). No wonder the S&P was trading at 8x. They are both long term competing instruments. To be competitive at a time when prices have fallen and the S&P’s earnings yield has risen to 12%, excluding large cash dividend yields.
The 10-year Treasury yield yesterday exited at 3.48, or an equivalent PE of 28.7 times. Plus the current yield on the S&P is 1.82%. That’s cash income before any appreciation. It may be noted that the same index return was close to 2013, when the S&P finally broke above 1,550. Since then, the index’s dividend income has nearly tripled, and earlier this year the index itself tripled before going down to earth. .
So I ask, from this perspective, is S&P’s valuation unreasonable at 18 times forward earnings projections?
And what? What now?
If Chairman Powell is true to his word (longer term), interest rates will rise on the short end of the curve, but as we’ve seen, this could backfire on the long end as investors run for safety. 10 years lowers that figure. Even if the opposite happens, say the 10-year yield hits 5%, the comparable Treasury PE drops to 20, which is still well above the S&P’s current PE. This is not my view of where things are going.
It is a stock market. Looking at forward multiples of the S&P 400 and S&P 600, I see much more value. They are 13.2 and 12.8 respectively (Yardeni Research).
Finally, “higher” doesn’t look so heavy until 0.5% to 5.1%, that’s after 12 months and a 400 basis point increase. There are signs that people are dumping stocks later this year, even though the economic news remains relatively positive, and reasonable people are already expecting some kind of economic lull (not armageddon) in the new year. Throw in a year of dire investor sentiment, and we look like we’re setting the stage for a pretty good rally.
What now. A closer look at the facts makes the case for a very attractive valuation of the current market (for most stocks)… time to buy, not sell.
What do you think?