Are stocks cheap yet? Not if the economy is slowing, these numbers say
Trying to figure out whether the U.S. stock market after the stunning decline of the last month is a bargain or not?
James Mackintosh’s “The Short View” column in today’s (August 23) Financial Times lays out in very clear terms one way to answer the question.
After a month of selling the Standard & Poor’s 500 Stock Index trades at just 10.3 times projected earnings. That’s below the forward price-to-earnings ratio in March 2009, the post-Lehman Brothers bottom. (The average since 1985 is 15.)
But that’s only cheap, Mackintosh points out, if projections for future earnings are accurate.
Right now forecasts by Wall Street analysts are calling for earnings of $108 a share for the 500 stocks in the S&P index. That’s higher than earnings on the index in 2007.
But in 2008 forecasts (and then actual earnings) plunged as the economy fell into recession.
A similar drop to that from 2007 to 2008 in today’s forecast earnings—which is what investors could expect if the U.S. economy dipped back into recession–would put the S&P 500’s price to earnings ratio at 17. That’s not cheap but rather expensive in comparison to the long-term average of 15 since 1985.
A 20% drop in forecast earnings—the rough equivalent of an economic slowdown instead of a recession—would put the price-to-earnings ratio of the S&P 500 at 13. That’s below the average of 15 but not really very cheap given the degree of economic risk that an investor is taking on right now.
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James Mackintosh is a new name to me, but obviously he’s been looking over my shoulder at my test paper!
Earnings are about to be flushed both in real terms and in comparisons. The easy comparisons to the depth of the recession that reports enjoyed last year are over. In fact as we enter this next recession, the comparisons will be to the relatively better earnings we saw last year when the economy looked like it was improving.
We have a quandary. Trailing earnings comparisons are about to tank, and I’ve never trusted projected earnings generated by analysts. Being an analyst is like being a weatherman, the job comes with a license to lie.
The Shiller PE or CAPE right now – about 21 – also makes stocks look pretty expensive.
Since 07 earnings were juiced by leverage, and that leverage has be largely flushed out, it is doubtful that a similar drop will occur.
AND don’t forget all the variables are scrambled now!! It is not only the US consumer, world’s #1 consumer, who faces recession but the REST of the world is hurting also, ie Europe, Japan, China, Brazil. Just WHO is supposed to pick up the slack. Savings only go so far!
We have FALSELY been conditioned that the market ALWAYS comes back. Just what if this global recession spreads. So, just buying on dips MAY NOT be appropriate.
I fear the Fed’s commitment to keep rates flat to falling for 2 years will result in many investors jumping to dividend stocks, bidding them up. What happens when earnings no longer support dividends?
There is just too much money out there!!
Gorm
Keep this in mind. No matter what the stock prices are, if the dollar is worthless, your stock is worthless. If your stock doubles in “value” and the dollar loses 60%(or more) of it’s “value”, where are you?
Worthless? you mean I won’t be able to sell my GE stock to buy a chevy? Why not?
as long as I pay my bills in the same worthless dollars in which I own stocks, does’t it all wash out?
Great article Jim!, I have been looking all over for this basic metrics.