No, that’s not the title of a post by Chuck. It is the very serious WSJ that published an article whose first phrase runs thus. For introducing a bit more rationality in an appreciation of the market, the article is quite brilliant at examining the fundamentals and the way the market is currently being overvalued.
For now, the economy appears to be living mainly on stimulus… However, the question is how long the banks will avoid having to clean up their balance sheets? Until the realization dooms that the core roots of the crisis are still present in the economy, the markets will continue to keep up their good performance.
Is the stock market smoking hot or just smoking something?
The S&P 500 has risen almost 60% in a little more than six months. Since it fell by almost half in the half-year prior to March’s low point, you might think that is fair enough: The sharper the fall, the more drastic the bounce-back.
At a superficial level, that is hard to argue with. Short of swarms of locusts sweeping the world, it is hard to imagine corporate earnings plunging as fast as they did in the latter months of 2008.
Still, after the market’s last cyclical trough, in 2002, it took more than three years for stocks to rise 60%. Stocks are ultimately discounting mechanisms. Judging what expectations are at any given moment is, granted, something of an art form. But some indicators are warning that, at 1070 points, the market has overreached.
The first, and simplest, is the price/earnings multiple. These come in various forms, but many look expensive. Trailing 12-month operating earnings, which exclude one-off charges, give a multiple of 27 times. The multiple of reported earnings is 142.
Looking ahead, consensus estimates for operating earnings result in a 2009 multiple of 19.5 times and 15.1 times for 2010, when analysts expect S&P 500 companies to produce earnings of $70.
Meanwhile, David Rosenberg, economist at Gluskin Sheff, reckons the S&P 500 is actually discounting earnings per share of $83 in 2010, using inflation-adjusted Baa-rated bond yields as a proxy for the cost of equity.
The chart above showing annual inflation-adjusted earnings for the S&P 500 since 1960 shows the sharp change that took place after the 1980s. Average annual growth roughly doubled from 1.8% between 1960 and 1990 to 3.5% in the period thereafter, 5.7% if you exclude 2008′s recession year.
The latter period included unusually moderate inflation resulting, in part, from IT-related productivity gains and, for much of it, low, stable oil prices. It also included, after 2001, the second leg-up in America’s debt-to-gross-domestic-product ratio that began rising in the 1980s. Banking on earnings shooting back toward their prerecession growth trend, as a figure of $70 to $80 would imply, seems ambitious in the absence of those tailwinds.
The one big stimulant keeping the market partying comes courtesy of Uncle Sam. But with unemployment rising, industrial capacity utilization still languishing under 70% and the housing market almost wholly dependent on federal help, clear signs of a sustainable private-sector revival are few. Post “cash for clunkers,” for example, vehicle sales look set to have slumped below an annualized rate of nine million units in September, according to Edmunds.com, a consumer-autos site. Cheap money and fiscal handouts might feel like narcotics, but are ultimately medicine for a sick patient.
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