Market Rally Exaggerates Reality - Gluskin Sheff

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."

Comments

[Larry House:]

Sobering but true.

Sep 21 03:49 PM

[Steve in Gr...:]

Like celebrities who are famous for being famous, this market is going up because it is going up.

Sep 21 04:34 PM

[themackattack:]

This market will keep going up until it is given a reason not to. It is difficult to say what the catalyst will be, but I don't expect any significant sell-off until there is one.

Personally, I plan to ride the bull until the start of Q3 earnings season, and then get very cautious. It will be disappointing earnings that slow this train down, due to valuation concerns.

Prior to that, only a fool would short.

Sep 21 07:50 PM

[SeekingTruth:]

The market level is seldom based on reality, or rationality.
It typically is based on either hope, greed, fear, desperation, delusion, dispair, or celebration.
And don't forget manipulation.
If it were rational, under these conditions, it would not be trading at a multiple greater than the historical norm times the next four quarters of expected earnings.
Even if a generous 20 times future earnings multiple were applied, it is difficult to see the S&P 500 above a level of around 820 or so.
So, once again, we have a Trader's technical market where the trend lines and momentum indicators, etc. rule the day.
Any serious negative event will cause this market to fall far below historical average valuation levels simply because there is so much air under it on a fundamental basis.
Don't use the rent money to particpate at these levels and be sure to have your next years monetary needs in reserve, at a minimum. Then, if you've got money that you could start a bonfire with , then enjoy the ride and the adventure.

Sep 21 08:08 PM

[Russ Wetherill:]

More like the market rally IGNORES reality. There seems to be a fundamental disconnect between what the stock market is doing and what the rest of the economy is doing. This creates a tension between the two that can't last forever.

Eventually one or the other, either the stock market or the real economy, will have to yield to the other. What is more likely, that the stock market will adjust downward to meet the economic reality of the real economy, or that the real economy will suddenly add several million jobs despite historically debt loads and historically low consumer confidence?

It's much more likely that fungible stock positions will be sold off than it is that consumers will begin spending instead of saving and that companies will begin hiring instead of firing.

Sep 21 08:35 PM