Why isn’t the stock market ready to soar, now that the bailout’s on its way, the DOW has declined 20%+, and cash has outperformed stocks more more than 10 years? Because:
- Stocks are still very expensive (25X trailing earnings)
- Analysts are still expected a v-shaped recovery in corporate earnings
Merrill’s Richard Bernstein lays out this case in Barron’s. We keep inviting readers to tell us why he and others who take this view are wrong. So far, no one has made a persuasive case. But please keep trying!
What would make you turn more bullish on equities?
We are looking for sentiment and valuation to improve, and we are looking for analysts’ estimate revisions to actually capitulate.
So earnings estimates are not going down as much as you expected?
No, not at all. Relative to history, you would never know there was an economic slowdown going on in terms of analysts’ revisions. That is largely because investors over all have not come to grips with the relationship between the credit crisis and the knock-on effects on the real economy: The next thing to look for is more defaults.
We are also watching jobless claims, which have been rising. Employment is very, very critical to the future of the economy…
Could you talk a little more about stock valuations and your concerns there.
We have never had the combination of 5.5% inflation and about a 25 multiple on the S&P’s trailing earnings. When we talk about a 25 multiple on the S&P, nobody can believe that it’s actually the trailing earnings. And then people say, “Well, if that’s true, it’s only the financial stocks.” Well, it’s not. It’s much more broad-based.
The market is just legitimately expensive, and we are so hesitant to use forward earnings, because analysts haven’t revised their estimates downward. So to say the market is selling at 13, 14, 15 times forward earnings is a meaningless statement.
What’s ahead for the economy, and how much more pain will there be?
That’s a hard question to answer, but investors who are looking for a sharp V-shaped recovery are going to be quite disappointed. I don’t see that happening. That’s because we are going through Phase I of this process, which is the deflation of the credit bubble. Phase II is the knock-on effects on the real economy, and we’re just beginning to see that.
For more on the valuation and earnings estimate problem, please see the following:
Are Stocks Cheap Yet? Unfortunately, No
And The Bailout…
RTC History Suggests Stock Market Not At a Bottom
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