— Is the S&P 500 PE expensive? Maybe in a perspective-free environment the answer is ‘yes’. But I am not perspective-free.
— In today’s media environment there are legions of market analysts who would say it is overvalued vs. historical the lows in the late ’70s and early ’80s where high rates and inflation pushed the PE on the S&P down to 8.
— This comparison is extremely superficial and does not come close to adequately comparing two eras.
— So what? Now What?
S&P 500 Expensive … Maybe in a perspective-free world!
Yesterday I turned on the tube to this country’s pre-eminent business network (it will remain nameless) to get a feel for the chatter surrounding the week’s tumultuous up/down market. I found myself in the middle of a debate as to whether the market (a la the S&P 500) was cheap or dear. The moderator was Scott Wapner and the panel included guest contributors, Cameron Dawson, John Mowrey and Bryn Talkington. Only one of the participants was armed with historical perspective (detailed knowledge of the inflation and rates 45 years ago). The other three were not. In the market the crowd (the three not possessing the facts) is always wrong.
In today’s media environment there are legions of market analysts who would say markets are overvalued vs. historical the lows in the late ’70s and early ’80s where the high rates and the inflation of the era got the PE down to 8 times. Few if any explain why today’s PE should be much lower. One of the panelists used this period as a good reason why the market PE should be much lower. This lack of perspective is the rule and not the exception for the media covering the market and the economy. Only one in four got it right in the clip above.
Superficial comparisons yield wrong answers
The one panelist who knew the 8 PE statistic did not dig enough to realize that the PE was there because rates and inflation were much higher 42 years ago versus today. We are talking about a peak yield on the US Treasury 10-year note over 15%. That would give you an equivalent PE on that bond of 6.7 times (100 divided by 15). It is no surprise that the S&P was trading at 8 times. They are both long-term, competing instruments. To be competitive at the time prices dropped and the earnings yield on the S&P increased to 12%, not including a hefty cash dividend yield.
The yield on the 10-year treasury went out yesterday 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. I might point out that was near the same yield on the index in 2013 when the S&P finally broke above 1550. Since that time the dividend income of the index has almost tripled, and earlier this year the index itself had tripled before falling back to earth.
So, I ask, based on this perspective, is the valuation on the S&P unreasonable at 18 times forward earnings estimates?
So what? Now what?
If chairman Powell is true to his word (higher for longer), rates will rise on the short end of the curve but as we’ve seen, this may have a countermining effect on the long end as investors run for safety in the bosom of the 10-year pushing that rate lower. Even if the opposite occurs, say the 10-year yield goes to 5%, the comparable PE on the Treasury note goes down to 20, still well above the S&P’s current PE. This is not my view of where things are going.
It is a market of stocks. Looking at the forward multiples on the S&P 400 and small-cap S&P 600 I see much bigger value. They are 13.2 and 12.8 respectively (Yardeni Research).
Finally, “higher” does not seem too onerous at up .5% to 5.1%, that’s after 12 months and a 400 basis point increase. There are signs of people throwing stocks away at this year end even though the economic news continues to be relatively positive and most reasonable people would already expect some sort of economic pause (not armageddon) going into the new year. Stir in a year-long period of awful investor sentiment and we would seem to be setting the stage for a pretty good rally.
Now what: A more rigorous examination of the facts makes a strong case for the current market (the great majority of stocks) being very attractively valued … a time to buy, not to sell.
What’s your take?
Happy Holidays to all and best wishes for a healthy, happy and prosperous new year!
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