S&P Still Considers This Market Cheap

Chrysler and General Motors are in the tank. Commercial mortgages can’t be found for many new projects outside of core urban centres. Large companies, such as American Express (AXP), are still laying off staff. The M&A market hasn’t returned, except for the buyers looking for a steal-of-a-deal situation. Announcements of stimulus funds are finally part of our daily media fare, but little of the cash will flow until 2010 at the earliest.

But the market continues higher. At least so far.

This despite the fact that Equity Research Analysts have pulled in their horns regarding 2009 earnings growth for the S&P 500. When I touched on this in February (see prior post “U.S. Bank stock analysts still too rosy about 2009” February 26-09), S&P 500 earnings were projected to grow by 21.3% for 2009 (versus 2008). Sounded impossible at the time, and it was.

Research Analysts have knocked that figure back to 9.4% growth, which implies the market is currently trading at a 16.8x current year EPS multiple. Now that’s well above February’s estimated 2009 price/earnings multiple of the S&P 500 of 11.85x.

This new forecast of 16.8x is mildly cheaper than both 2007 and 2008’s 17.8x and 18.3x respectively.

For 2010, Equity Analysts are looking for 37.5% earnings growth for the S&P 500. Financials, Consumer Discretionary, Energy and Materials are all slated to have 2009 EPS growth of more than 90% next year. Which means the market is trading at just 12.2x forward earnings. Not far off the 11.85x multiple that Analysts were publishing on February 26, 2009.

Since that date, the S&P has rallied 18.7%. Sounds like a buy?

Not so fast. This from the New York Times a few days ago:

On Friday, economic data showed the American economy lost a further 539,000 jobs in April and the unemployment rate leapt to 8.9 percent — a sign that the United States might already be heading toward the worst case, although the job losses were less than Wall Street expected.

Despite the sobering outlook, the mood on Wall Street was generally upbeat after the rosier-than-expected assessment of the biggest banks. The stock market climbed, with the Standard & Poor’s 500-stock index gaining 2.4 percent on Friday.

“If there were holes in this, the market would have seen it,” said Stuart Plesser, an analyst at Standard & Poor’s.

Famous last words. I don’t subscribe to the theory that “if there were holes” in something, the market would have found them. Where were the predictive powers of the market on Bear Stearns (BSC), Lehman (LEH), Citigroup (C), General Motors (GM), etc.? If we’ve learned anything over the past 27 months, it is that that just isn’t a reliable science.

What the market does know is that the chance of a Depression was averted with the suspension of the banking mark-to-market rules. That has fueled the post March 9th rally.

10 weeks ago, analysts thought 2009 earnings would grow 21.1%. Today they are counting on less than half that figure.

And in 10 more weeks, could it be zero?

Comments

[jamookey:]

Biriny,Lefkovich,Leuthold must all be idiots if one listens to this author.True that the economy is not going to the moon anytime soon,but I hate to remind the author that the market looks forward,not backward.We shall see.

May 21 08:29 AM

[Archman Inv...:]

<<What the market does know is that the chance of a Depression was averted with the suspension of the banking mark-to-market rules. That has fueled the post March 9th rally.>>

No.
What has fueled the rally since March 9th has been hedge funds and IB trading desks using TARP money to make the market go higher.
Average Americans (i am not talking about people who trade stocks for a living) did not participate in this bear market rally for we know from history that they remained shell shocked from the losses sustained over the past 12 months.
Unlike 25 years ago when hedge funds were far and few between, hedge funds are now responsible for the majority of stock price / index movements. The simple fact of the matter is, hedge funds, the trading desks decided enough is enough, it was time to make some money on the long side. And boy they made it.
Unfortunately average americans did not participate in the rally, and of course, as if right on point, analysts began upgrading the most beaten down sectors AFTER they shot up more than 100% from their lows.

This is typical Wall Street behavior. Telling investors what they want to hear, rather than what they need to hear.

It is going to take more than a handful or positively spun news points to convince folks that everything is looking better.

May 21 08:33 AM

[One Eyed Guide:]

Good article but I'll pick on you for the same reason as Archman Investor.

Not only has the suspension of mark to market rules not averted the chance of a Depression, history says that it actually increases the chance of a Depression because it allows banks to hide problems longer. Economic production requires financing and as long as banks have structural problems, their ability to lend will be restricted and growth will be lower than it could be.

Give banks enough cover and let things deteriorate too long and you end up with a Great Depression due to lack of capital for production. On the other hand, if you let banks fail quickly (and make sure that depositors are OK with high limit FDIC insurance) only the investors and bond holders get hurt. Any one who holds a bank stock or bond at this point is a speculator and their money is at risk.

During most of the S&L crisis the economy continued to expand so we don't necessarily have to have a depression, or even a recession due to a bank crisis. It's jsut the way that this one has been managed that has caused the problems.

May 21 01:12 PM

[kmf:]

.
I don't know whether the market is undervalued but if you use a dividend discount model with short term rates at their current levels then any company with "solid" dividends are worth a heck of a lot more than their current prices.

The actions of the govt. manipulating the interests rates to such a great extent has made valuations extremely difficult- the big question is how long will the govt. hold down the rates and not let them seek the market levels. And now the dollar is beginning to tank!

May 21 02:14 PM

[Old Trader:]

kmf,

The problem would lay in finding the companies with "solid" dividends. Even if there's no chicanery with the books, there's always the very real possibilty that a company might choose to cut/eliminate their dividend as a precautionary measure, given that credit markets are still tight. I wouldn't wonder if that's not a large part of the reason so many are advising looking at good grade corporate debt, rather than high yield stocks for income oriented investors.


On May 21 02:14 PM kmf wrote:

>
> .
> I don't know whether the market is undervalued but if you use a dividend
> discount model with short term rates at their current levels then
> any company with "solid" dividends are worth a heck of a lot more
> than their current prices.
>
> The actions of the govt. manipulating the interests rates to such
> a great extent has made valuations extremely difficult- the big question
> is how long will the govt. hold down the rates and not let them seek
> the market levels. And now the dollar is beginning to tank!

May 21 07:39 PM

[buoy:]

...1,500 from the bottom, 6000 from the top

May 23 07:50 AM