Some bulls are claiming the S&P is now cheap by historical standards (ironically after a record rally in stocks that made them more expensive!)
Their shouts of bullish fundamentals are erroneous, according to acclaimed fund manager John Hussman. In his latest market commentary, Hussman writes:
On a valuation basis, the S&P 500 remains about 40% above historical norms on the basis of normalized earnings. The disparity between our valuation assessment and the putative undervaluation being touted by Wall Street analysts is so great that a few remarks are in order. First, virtually every assessment that “stocks are cheap” here is based on the ratio of the S&P 500 to year-ahead operating earnings estimates, and often comes with a comparison of the resulting “earnings yield” with the depressed 10-year Treasury yield. What’s fascinating about this is that this is the same basis on which analysts deemed stocks to be about 40% undervalued just prior to the 2007 top, following which the market plunged by more than half. There’s a great deal of analysis regarding forward operating earnings that I published in 2007, but probably the most comprehensive piece was Long Term Evidence on the Fed Model and Forward Operating P/E Ratios from August 20, 2007.
When you hear analysts say that the historical average P/E ratio is about 15, you have to recognize that this is the normal P/E based on trailing 12-month earnings after subtracting all writeoffs and other charges. Forward operating earnings are invariably much higher, and it turns out that the comparable historical norm, as I discuss in that 2007 piece, is only about 12. If you exclude the late 1990’s bubble valuations, you get a historical norm closer to 11.5. The 1982 and 1974 market lows occurred at about 6 times estimated forward operating earnings.
To me, this is the crux of the entire bull/bear argument. Beyond technicals, or earnings, or anything – it all comes back to valuations.
March 2009 was probably not the secular low for this bear market, because valuations weren’t low enough yet. And they probably won’t be until about 2015 or so.
Assuming a ~16 year bear market (which is about the norm, the last was from 1966-1982), and assuming this one started in 1999, you probably want to just set your alarm clock for 5 years from now in 2015. If valuations are cheap enough at that time – ie. P/E’s around 5-8, and stocks yielding 5-6%, then by all means “go long”!
But until then – I’m not buying these rallies, or calls to buy based on “cheap fundamentals”. They are erroneous!