Market
Valuations – High or Low?
There are various ways to compute market valuations (most use the
S&P500 as the market). If you use
10-year trailing average earnings you get a high valuation. But this includes
earnings in two deep recessions within 10 years of each other. 10-year averaging at this point makes no sense
when earnings are at a cyclical low. Markets are forward looking.
Defining earnings - Reported earnings
computed under GAAP rules of CPAs, includes losses on discontinued
operations and various other onetime charge-offs. P/E’s using this method
result in high P/E ratios. “Income from current operations” also called
“operating earnings” is a better definition of earnings that is most commonly
used. It is usually either “trailing” or “forward” over a 12 month period.
Trailing 12 months earnings inflates the ratio since the S&P500 had
negative earnings in the 4th quarter of 2008. If that happened four
quarters in a row, the P/E would be infinite. But the S&P obviously
wouldn't be worth zero. Yale professor Robert Shiller
who is widely quoted modifies the 10-year data by taking into account
inflation. Alan Greenspan, influenced by Shiller’s
work, made his famous "Irrational Exuberance" speech before the
“dot-com” crash.
The so called “Shiller P/E” stood at 17.7 as
of 8/18/09 (per article of 9/1/09) This is almost the same as his computed
average since 1928 of 17.4.This 10-year method includes the latest two deep
recessions and the current cyclical low of earnings.
In my view the best market valuation is using consensus estimates of
next 12 months or for 2010 operating earnings. The S&P Index Service
updates the 2010 estimate weekly. As of 9/08/09 the forward estimated earnings
for the S&P500 Index is $72.98. Using a 1040 S&P500 value the P/E ratio
is a relatively low 14.2. Using a reasonable P/E of 20 at this stage (discussed
later) that results in an S&P500 level of 1460 in 2010 or 40% higher than
the recent 1040 level. Of course this
cannot be assured and assumes no new crisis. That is why “participate yet protect”
strategies are important.
Historically these forward estimates are
usually conservative, with actual results beating estimates. For
example for 2nd quarter 2009 about 75% of the S&P500 companies
beat estimates. (Source: Bloomberg 8/28/09) We don’t recommend investing
in a “dumb” index but in carefully selected choices with long-term histories of
beating the indexes.
A number of investment professionals say that
a reasonable P/E ratio for the current market is about 20. On CNBC Squawk Box in late August Byron Wien,
the incoming vice chairman of The Blackstone Group is sticking to his previous
prediction for S&P1200 by year end (up about 15% from now). This is based
on his estimate of a reasonable P/E ratio of 20.
Denis Ouellet, with
34 years experience managing equities has an extensive blog with a very
detailed equity valuation analysis using his “rule of 20” for P/E saying, “since about the
mid-fifties “PE + Inflation” has been around 20, generally oscillating between
15 and 25.” He uses P/E 20 as current fair value. On 8/25/09 he says that using
not 12 month estimates but consensus estimates for 3rd and 4th
quarter 2009 “equity markets have room to advance 19-25% to 1120 -1280
(S&P500) before they reflect fair value.”
Kiplinger.com “Ride
This Bull Market”
9/1/09 Highlights:
“If you've been on the sidelines, it's time
to buy stocks. The big-picture thinkers I trust most say the
bull market is far from over. $3.6 trillion is currently parked in money-market
mutual funds-even though they yield virtually nothing. That's a lot of fuel to
lift the market higher. But don't take my word for it. Listen to Steve
Leuthold, who heads the Leuthold Group. Or to Jim Stack... Both are savvy
veterans.
Leuthold tracks 190 indicators, which measure
everything from how cheap or expensive the market is to the level of pessimism
or optimism among investors. He also studies economic conditions.
As a group, the indicators are currently more
bullish than they have been at any time since 1989 -- except for a month ago.
Leuthold says the S&P 500 will likely rise to 1200 by year-end, a gain of
almost 20% from its August 31 close of 1021. ‘We're not looking for a robust
recovery,’ says Andy Engel, Leuthold's senior
research analyst. ‘But we should get good-size stock returns over the next six
to 12 months.’
Stack, president of InvesTech
Research comes to nearly the same conclusion: ‘Virtually all the technical
blocks are in place for a bull market’
Whenever we've had a horrible decade, the
market has produced terrific returns in subsequent years. And while the
economic recovery will be subdued, corporate earnings will jump compared with
their depressed levels of the first half of this year”.
Even if Stock Selloff is Coming, You Don't Have to Join
Crowd - 8/31/09
CNBC - The prevailing sentiment seems to be that even if a correction does come
along, it will be healthy for the markets. Now is not the time, market bulls
say, to be taking money off the table. One advisor said, "I'm not sure
September is going to be the evil month that many people expect.”
Another portfolio manager said "a
correction could come, but it won't be anything devastating—perhaps 7 or 8
percent—and will be a healthy detour on the market's way up." Matthew
Tuttle another manager who has been long-term bearish says, "At least in
the short term, for the rest of the year, we would look at any correction—5, 6,
7 percent—more as a buying opportunity than real reason to panic," he
says.
The "sell in May” adage didn't work this
year as earnings beat expectations by a wide margin. Markets always wipe out
excesses and build a foundation again. The excesses have been wiped out and
they're building on a foundation, and you're going to have a pretty good market
going forward."
Consumer Spending Could Rebound Faster than Expected - Consumers overall have dramatically built
savings. Once a bit of consumer confidence returns there
could be a lot of pent-up demand for goods and services as evidenced by the
“Clunkers” program.
Stimulus Plan on Schedule – The tax cuts for most are in place.
Stimulus funds are preventing the layoff of many teachers, police and providing
funding for many projects. The bulk of the stimulus, for infrastructure, was
never expected to be spend until 2010. This can help
bridge the gap if consumer spending doesn’t pick up quickly. The Treasury has
made huge profits from the TARP “bailout” program, with more to come as banks
repay their loans and buy back their warrants. Demand
for increasing Treasury debt is still very strong. U.S. government debt levels
are still not particularly high compared to many other countries.
“Participate yet
Protect"- Most
of our clients need reasonable growth to fund 20-30
years of active, healthy retirement and need some protection strategies from large market losses. A 65-year old American
husband and wife couple has a 50% chance that one of them will live at least 27
years to age 92 (Source: On Wall Street, SOA).
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on a CPA firm background
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The views and opinions expressed
by Dave Hutchison, CFP are as of the date of the report, and are subject to
change at any time based upon market or other conditions. The material contained herein is for
informational purposes only and should not be construed as investment advice,
since recommendations will vary based on a client’s goals and objectives.
Information is believed to be from reliable sources; however, no representation
is made as to its accuracy. All economic
and performance information is historical and not indicative of future
results. Please consult one of our
financial advisors for more information. Hutchison Investment Advisors, Inc. is
an
Securities are offered through Multi-Financial Securities Corp, Member FINRA/SIPC. Investment advice is offered through Hutchison Investment Advisors, Inc, a Registered Investment Advisor. Multi-Financial Securities Corp. is not an affiliated company of Hutchison Investment Advisors, Inc., or Hutchison Financial Advisors.
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