Good morning. Since I flat-out refuse to waste your time with predictions about which stocks or sectors will/won't perform well based on the outcome of the presidential election (anybody recall how all those "Obama stocks" fared after the election in 2008?), I've decided to forgo any of the crystal ball stuff that is oh-so popular this week. As such, I thought we should get back to business and continue our objective review of stock market valuations.
If you recall, in Tuesday's missive we took a look at a couple of different P/E ratios for the S&P 500. And while valuation zones can change dramatically over time, our conclusion was that relative to long-term means and medians, the S&P is basically right around fair value at the present time. Another way to look at this is that based on our GAAP P/E analysis, in order for stocks to become expensive in 2012, the S&P would need to hit nearly 1800 (1797 to be exact) before the end of the year. This means that the S&P could rally another 26% from yesterday's close before the S&P became overvalued based on 2012 GAAP earnings estimates of $89.88. Granted, this is very unlikely to happen, but it does put things into perspective.
I also promised yesterday to review some of the other valuation metrics for the S&P 500 such as Price-to-Book Value and the Price-to- Dividend ratios. Oh and lest I forget, I also said we'd look at things from a global perspective. So, since the polls are closing and the fun is about to begin, let's get to the task at hand.
There is a very good reason that most folks don't spend a lot of time talking about the Price-to-Book Value ratio. In short, the ratio has been all over the map over the last 35 years. For example in 1978, the P/BV ratio was about 1.15 and a range between 0.98 and 1.5 existed until the early 1980's. However as the great bull market began, the ratio moved steadily higher. In 1987 it was 2.38. In 1994 it was more like 2.6 and by 2000, the ratio had skyrocketed to over 5.0. Since the turn of the century the ratio has moved steadily lower until it hit 1.4 in 2008. Since then the P/BV ratio has moved in a range of between 1.9 and 2.3. So... the current reading of 2.2 is at the high end of the range we've seen since the credit crisis ended. However, since the average over the last 35 years has been 2.38, one could argue that stocks remain undervalued here. The bottom line is I'll call this one a toss-up and wouldn't pay much attention to the readings.
Now let's turn to the Price-to-Dividend ratio. A lot of people like this because dividends represent cold, hard cash that gets paid out to shareholders. However, the problem is that in the late 1990's companies began to buy back stock instead of paying out dividends in order to "manufacture" stronger earnings numbers. So, from 1915 through 1990ish, the range was pretty clear. A P/D over 31 for the DJIA was expensive, the average was 24.5, and stocks were cheap at around 17. So, given that the current reading is about 40, it sounds like the DJIA is expensive.
But as we've mentioned, times change and markets change too. In fact, since 1990 the P/D range on the Dow has been very different. The low end has been around 21, while the high in 2000 was 67. As such, the average since 1990 looks to be about 45. So... based on long-term data (back to 1915) the Dow appears to be very overvalued. However, in the more modern era where dividend payouts have been out of vogue, the current payout level of 40ish is actually below the average.
One can also look at the dividend ratio as a sentiment indicator. In short, the amount of money a company is willing to payout in the form of a dividend is a reflection of the company's confidence in the future. So, the current payout ratio looks to be about normal or perhaps a little below at this stage.
Another approach to valuation is to look at P/E's relative to the level of interest rates and/or inflation. Given that the current interest rate environment is being artificially influenced by the Ben Bernanke's cavalry, it probably makes more sense right now to look at rates relative to inflation. I won't bore you with all the math and assumptions involved, but I will tell you that this indicator says stocks are pretty darn cheap at the present time.
Finally, if we look around the world via the MSCI World Index, we see that stocks also represent good values right now. According to Thomson the current median P/E for the MSCI World Index is 14.7, which is well below the median of 17.6 seen over the last 18 years. And if you look at the valuation levels prior to 2008, the current reading would be the second lowest on record.
So, what's the bottom line? Based on several different views of P/E's, a couple approaches to P/D, a review of the P/BV, and a glance around the globe, it appears that stocks are no worse than fairly valued at the present time. And while it is hard to argue that stocks are cheap after the S&P has moved up +111% since March 9, 2009, it is also quite clear that stocks are not expensive by any stretch of the imagination.
From my perch, this means that if we can get past the issues of the Fiscal Cliff, the economic slowdown, and Europe's debt mess, stocks could enjoy some serious upside over time. However, that may be putting the cart about a mile in front of the horse right now.
Turning to this morning ... The president's relatively easy/early win was initially celebrated in the futures market with modest gains overnight. However, in the last hour the euro has suddenly taken a big hit on comments from ECB President Draghi, which has caused the U.S. dollar to rally and, in turn, a "risk off" trade has been put on in stocks. Futures now point to a fairly significant decline at the open.
Thought for the day ... "The Democracy will cease to exist when you take away from those who are willing to work and give to those who are not." - Thomas Jefferson
Major Foreign Markets:
- Shanghai: -0.00%
- Hong Kong: +0.71%
- Japan: -0.02%
- France: -0.42%
- Germany: -0.28%
- Italy: -0.93%
- Spain: -0.80%
- London: -0.22%
- Crude Oil Futures: -$1.29 to $87.42
- Gold: +$4.90 to $1719.90
- Dollar: lwerer against the yen and pound, higher vs. euro
- 10-Year Bond Yield: Currently trading at 1.646%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: -10.64
- Dow Jones Industrial Average: -100
- NASDAQ Composite: -25.50