The Market Looks a Bit Rich
06/08/2009 12:00 pm EST
Sam Stovall, chief investment officer of Standard & Poor’s, says the recent rally has pushed valuations high and made several sectors look pretty expensive.
The first-quarter 2009 earnings reporting season is pretty much over. Operating earnings for the Standard & Poor’s 500 dropped 39% year over year, led by a 104% decline for the S&P 500 consumer staples sector; an 83% slide in the consumer discretionary group, and a 75% drop in materials. Through the quarter, however, the S&P 500 index advanced 11.2%.
So, what is the reason for the discrepancy? Maybe there wasn’t one, [because] the S&P 500 recorded a 25% decline through March 9th as investors anticipated the worst from first-quarter earnings reports and became convinced the US government would nationalize the US banking system. Neither worry materialized, thus allowing share prices to experience at least a sharp rally within a bear market.
Historically, valuations are low at bear market bottoms, thus allowing for P/E expansion as share prices advance. Since 1937, the median P/E for the S&P 500 at bull market highs was a shade below 19x on trailing 12-month GAAP earnings, with only 1980 sporting a peak P/E in the high single digits and six of the remaining 12 observations recording valuations of 20x or higher.
At bear market bottoms, however, the median P/E was 12.6x, with five of the 13 observations below 10x and six more between 11.6x and 15.1x. On March 9th, the S&P 500’s P/E on trailing 12-month GAAP earnings was a whopping 97.9x, as it included the $23.25 per-share loss in 2008’s fourth quarter.
But if some believe this is a perfect example of why operating earnings tell a better story, don’t get too optimistic. The S&P 500’s operating P/E was trading at nearly 16x earnings on March 9th, slightly below the median of 18x since 1988. As of May 22nd, however, the S&P 500 was trading at more than 22x trailing, 12-month operating results, 16.4x 2009 estimates, and nearly 12x 2010 estimates.
In other words, even though the S&P 500 bounced nicely off of its early March lows, it may not sustain its upward trajectory for too much longer, as valuations become increasingly stretched. S&P equity analysts are looking for the S&P 500 to earn $54.14 a share in 2009, up 9% from the $49.51 recorded in 2008. Early 2010 estimates point to a more than 39% advance to $74.99, which may prove to be a bit too optimistic.
Rich valuations may also hold back further sharp advances for cyclical sectors in the S&P 500, such as consumer discretionary, financials, and materials—even if you overlook 2009 estimated multiples of 48x, 51x, and 33x, respectively, and focus on the more palatable 2010 multiples. Valuations begin to look more plausible, in our opinion, the further out you go. Of course, the confidence in these earnings projections wanes as well.