A fundamental pillar of the bull case in equities is that, well, stocks are just too cheap not to buy right here, with the S&P trades at 12.7x earnings.
In a brilliant note out today, Morgan Stanley’s Adam S. Parker, Ph.D plays devils advocate, laying out reasons why the market isn’t so cheap.
We summarize them:
- The PE isn’t that cheap. The market is actually in the 43rd percentile of cheapest markets — not ridiculous by any stretch.
- Profit margins are high, so on a price-to-sales ratio, the market isn’t that cheap.
- Dividend yields remain low on a historical basis.
- Most of the cheapness is in the mega-caps. Excluding them, the market is right in the middle of hits historical range (see chart below).
- While it’s true that cash balances are high — also a part of the bull case — a lot of that cash is parked overseas where it can’t be touched. Also, because of low interest rates, it’s not generating much income.
- A rebound in inflation, historically, would indicate further multiple compression.
- EPS volatility is also historically tied to multiple compression.
Here’s the chart, mentioned above, on the EPS gap between the biggest mega caps and the rest of the market.
Ultimately, Parker thinks the multiple could go to just 10x.
Combine all this with another bit of analysis from Morgan Stanley — the case for a secular downdraft in corporate margins — and it’s easy to be bearish on stocks right here.