With the market totally shrugging off any of the recent ructions, David Rosenberg of Gluskin-Sheff turns his attention to the simple question of valuation.
According to the Shiller P/E ratio, the S&P 500 is now 35% overvalued — a full
one standard deviation event.
The April data was just updated and showed the inflation-adjusted normalized
P/E, premised on “bird-in-the-hand” (as opposed to consensus earnings
forecasts, which is historically more than 20% higher than we actually get — one
reason why Wall Street banks are dubbed “the sell side”) 10-year trailing profits,
expanded to over 22x from 21x in March.
This is not nosebleed territory, but it is expensive; the historical average is 16.4x.
So, this implies that the market is currently 34.7% overvalued benchmarked
against the historical norm. It would be nice to say that a higher-than-normal
P/E is justified by low inflation and low interest rates. But frankly, real bond
yields are not that far from their long-run averages; however, equity valuation is,
and something is going to give at some point.
Valuation metrics are not meant to be timing devices. Assets, securities, and
currencies can stay overvalued for extended periods of time, but inevitably Bob
Farrell’s rule number one on the concept of “mean reversion” will come into
play. The operative strategy is to buy low and sell high, not the opposite; and to
be paid to take on risk as opposed to be paying for taking on the risk.
Defensive income-oriented strategies, at this point, make perfect sense from our
We expect the valuation debate to get more and more attention in the days and weeks ahead.
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