Another look at S&P valuations
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Overvalued In Every Way
No matter what the economy does or doesn’t do, the market is extremely overvalued any way you look at it. A few days ago one of the anchors on CNBC stated as if it were fact, that the stock market always looks overvalued on depressed earnings. Unless we go back to 1932, this simply is not true. At the ten bear market bottoms of the past 50 years, the P/E ratio of the S&P 500 averaged 11.3 with a range between 16 and 7. The dates of these bottoms and the P/E multiples at the time are as follows: 1) October 1953, 9.0. 2) October 1957, 11.6. 3) October 1960, 16.0. 4) June 1962, 14.2. 5)October 1966, 13.2. 6) May 1970, 13.5. 7) December 1974, 7.0. 8) February 1978, 7.3. 9) August 1982, 7.1. 10) October 1990, 13.8.
By way of comparison, the S&P 500 at its September 2001 low of 944, sold at 37.8 times that year’s reported earnings of $25. Even now, if we take into account today’s close of 1146, the S&P is selling at a hefty 32 times 2002 earnings if we accept Merrill Lynch’s estimate of a 44% rise in earnings to $36. Now let’s take another step. Recall, as we have pointed out on numerous occasions, that the long-term average P/E ratio for the S&P 500 is 15. If the index sold at at 15 times the $36, it would come to 540, a full 53% under current levels. Merrill also projects 2003 estimated S&P 500 earnings of $49, a 36% gain over 2002 and a two-year increase of 96%. Even on the 2003 estimate the index is still selling at a multiple of 23.4 times earnings and would have to fall by 36% to sell at 15 times. Keep in mind, too, that these estimates are extremely generous. Over the past 52 years the greatest one-year increase in S&P 500 earnings was 39.8%, and the highest cumulative two-year rise was 60.2%.
Suppose the market didn’t fall a lot from here, but stayed in a trading range until earnings caught up to the price, and the index again sold at 15 times earnings. We’ll be liberal and assume that earnings jump 96% to $49 in 2003. From that recovery point we’ll further assume long-term earnings growth of 6% annually, which is the average over a long period. In that case earnings would have to reach about $76 in order for the current index of 1146 to equal 15 times earnings. Under these assumptions the $76 level would not be reached until the year 2011.
We know that these are a lot of numbers to swallow in a short comment, but we wanted to state the valuation case as clearly as possible, and if we don’t get specific, readers e-mail us asking for additional data. In our view it’s clear that the market is extremely overvalued from any angle. Although some observers make the case for a permanent level of overvaluation, we believe that is a very risky assumption to make. "
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