The rebound in equity markets over the past six months wildly exaggerates the economic landscape of the moment, says David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates.
And with the S&P 500 now trading north of a 26x price-to-trailing earnings ratio, the next twelve months is shaping up to be a rough one for investors.
"Going back over the last six decades, we know that the market typically faces serious valuation constraints once it breaches the 25x P/E multiple threshold, he said in a note to clients.
"The average total return a year out for the S&P 500 is -0.3% and the median is -6.2%. The total return is negative a year later 60% of the time, so when we say that there is too much growth and too much risk embedded in the equity market right now, we like to think that we have history on our side."
Mr. Rosenberg said the 60% rally of the March low assumes wrongly that GDP has expanded by 5.3% on average and that corporate profits are growing at 34%. In reality, GDP and corporate earnings are just now bottoming.
Furthermore, the stock rally is pricing in an employment rebound of 2.1 million and a rise in bank lending of 16.5% on average. But both employment and bank lending continue to decline.
At its current valuation, Mr. Rosenberg said the S&P 500 is priced for US$83 in operating earnings per share, which is nearly double from the most recent fourth quarter trend.
Meanwhile, consensus bottom-up estimates are predicting US$73 in operating earnings per share in 2010, with US$83 not likely until 2012.
"The market is basically discounting an earnings stream that even the consensus does not see for another two to three years," he said.
"In other words, this is more than just a fully priced market at this stage."