Joe Weisenthal notes David Rosenberg’s comments that the stock market is overvalued. I’m sorry, I just don’t see how you can argue against this market on a valuation basis. Could there be a double-dip? Sure, that’s a risk and I can’t say how large. But the idea that the market is not only high, but dangerously high, makes no sense to me.
While we will not belabour the point, when all the write-downs are included, the trailing P/E on “reported” earnings just widened to its highest levels in recorded history of nearly 140x (see chart below), which is three times the levels prevailing during the height of the tech bubble.
Yes, but that’s extremely depressed trailing earnings. When the economy tanks like that, these metrics lose some of their usefulness. Also, whenever the stock market initially spikes, it’s common for the P/E Ratio to rise since stocks are going up while earnings are still going down.
Rosenberg notes this criticism and compares today’s valuations to previous depressed earnings environments. Still, outside the great depression, the historic comparisons aren’t in the ballpark. Once we get Q4 2008 off our backs, then things will start to look like normal and we can again use traditional metrics again.
Another fact that the valuation argument must address is the low interest rates. As interest rates go down, valuations tend to rise in order to be competitive so I would expect higher multiples.
Rosenberg rightly notes that relying on future earnings is tricky since these are rarely correct. That’s true, but this is a crucial point and it goes back to my disagreements with Nassim Taleb. The forecasts and models don’t need to be perfect. They simply need to be reasonable.
In making a valuation judgment we need to make reasonable assumptions. For example, I recently said that corporate profits are likely to grow faster than the economy for the next few quarters (say three year).
Here’s a look at corporate profits’ share of GDP.
As you can see, it looks to be below trend. Note that I’m not predicting exactly where it will go, but based on past info, I’m making an assumption that profits will take up a larger share of the economy in near future. This is why I believe the Street estimates of $92 earnings for the S&P 500 in 2011 are reasonable, which makes the market well priced, if not a little on the cheap side.
(This post originally appeared at the author’s blog)
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