Mar 8th 2012, 15:20 by Buttonwood
BLOOMBERG has a piece today about how the S&P 500 is 9% cheaper, pointing out that the index's
price-earnings ratio of 14.1 matches the average level last year. The valuation has trailed the five-decade average of 16.4 for the longest stretch since the 13-year period beginning in 1973, according to Bloomberg data.
Now I'm not having a go at the news agency, which is an excellent source of information and analysis. But it is typical of bull market reasoning. I scanned the article for alternative valuation measures. No, there was no mention of the Shiller p/e (which averages earnings (over 10 years) and highlighted the four great market peaks of the 20th century. Go the professor's website and you will find the current p/e is almost 22, well above the historic average. So the market is not cheap at all on that measure.
Some people don't like the Shiller p/e saying that it's distorted by the collapse in earnings in 2008 and 2009 (this is a very strange argument since financial earnings were artificially boosted in the boom). So how about the dividend yield, a long-used measure (and also not mentioned by Bloomberg)? That's just 2%, according to today's FT, a long way below average, and another indication of a lack of cheapness.
What about buybacks, the modern way of returning cash to shareholders? The trouble is that bulls tend to count the shares that companies buy back, but not the ones they issue (often to insiders). In a piece* by Robert Arnott for the CFA institute, he finds that net equity issuance has averaged 2% a year over history. So even if one assumes that the modern buy-back ratio is as much as 2%, all of that is cancelled out by issuance.
Perhaps the S&P 500 will keep rising this year. But if it does, it won't be because the index is dirt cheap.
* It is in a set of essays called Rethinking the Equity Risk Premium. Sorry no link.
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S&P valuation is lofty, so expect the S&P to lose ground to inflation for yet another decade. Valuation is useless as a short run predictor, but uncannily accurate in the decade range.
Granted, the S&P 500 is not cheap by historical standards. But it does not look so bad when compared with US government bonds (and possibly gold, though it's harder to tell). A 2% dividend yield with some possibility of growth, or lock you money up for 10 years to get the same 2%? Pick your poison.
The market is not cheap because margins are at a peak & costs are rising. So profits likely flatten. One should normalize margins, forecast sales rising at what goes with 2.5% GDP growth, calculate profits & then see what PE correlates with that rate of year over year profit growth. Not alot to look forward to. We need a new label for something like "stagflation lite", say 2.5% growth with 2.5% inflation. Suggestions welcome.
"Perhaps the S&P 500 will keep rising this year. But if it does, it won't be because the index is dirt cheap." Indeed, and it won't be because the index is even REMOTELY cheap. It is expensive, plan and simple.
There is nothing wrong with bull market reasoning if there's a bull market. It does, however, look stupid if the market goes the other way.
http://www.cfapubs.org/doi/pdf/10.2469/rf.v2011.n4.full
there you go..may be?
Has anyone caught the slightest whiff of euphoria yet?
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
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