David Rosenberg has been on the wrong side of the market since March, but he isn’t backing down. Here he is in the FT, as bearish as ever:
Usually at bear market troughs, the S&P 500 goes to silly cheap levels. It did not this time round and, six months and 60 per cent later, there is yet again, in 2007 style, tremendous risk in this market.
Never before has the stock market surged this far, this fast, between the time of the low and the time the recession (supposedly) ended. What is “normal” is that the rally ahead of the recovery is 20 per cent. This market is now trading as if we were in the second half of a recovery phase, yet it has not even been fully ascertained the downturn is over…
An unprecedented eight-point price/earnings multiple expansion during a six-month faith-based rally has left the market at its most expensive (26 times operating profit, 180 times reported profit) in seven years. On a reported basis, this market is nearly four times overvalued, as it was during the tech bubble! Indeed, when we look at the history books to see what happens after the P/E multiple on trailing earnings pierces the 25 times threshold, the average total return a year out is -0.3 per cent and the median is -6.2 per cent. The total return is negative a year later 60 per cent of the time, so when we say that there is too much growth and too much risk embedded in the equity market right now, we like to think that we have history on our side.
[W]hat if the stock market were pricing in the same 2 per cent growth rate the corporate bond market is discounting? Answer: 842 on the S&P 500. So, if you’re asking us if we think we will see a 20 per cent correction in equities, the answer is Yes. Sure, there could be another 100 points left in the S&P 500 from here to the upside in the near term, but it is seldom wise to chase an overvalued market to the top unless you are gifted enough to know when to call it quits.
So that’s David’s latest.
What do we think? We don’t like to use single-year PEs, as David does above, because they often provide misleading pictures of value. (Bulls will argue that the trailing earnings Rosenberg cites above are artificially depressed “trough” earnings and that they’ll bounce right back.) We prefer the cyclically adjusted PE ratio popularised by Robert Shiller, which smoothes out the impact of the business cycle.
That said, the cyclically adjusted PE (below) supports the same conclusion: Stocks are about 20% overvalued.