Thursday, 19 February 2009

Stocks Far From Cheap

Last week I wrote about a US Corporate Earnings Collapse in which I commented that the 4Q08 S&P500 earnings both on an operating and as reported basis would be the worst quarter so far in this cycle. Just one week later and it has gotten worse still.

To put it in perspective, 4Q08 Operating earnings are now expected to be $5.29, that is the worst quarterly performance since September 1992. Not only that, reported earnings are now expected to be -$11.03 the worst quarter ever recorded.

Turning to PE's the 12 month trailing PE ratio for S&P operating is approximately 16.5x to the end of Dec 08. When the S&P500 peaked in August 2007 the P/E was approximately 17.0x times so despite the index halving, the overall market multiple has barely contracted.

If S&P500 earnings forecasts are to be believed, the forecast Dec09 PE falls to about 12.0 times. However as we know those forecasts should not be believed. Do we really think that an earnings recovery is going to get underway in the second quarter of this year? If you do I have bridge I'd like to sell you.

On the question of whether stocks are cheap or not the chart below is interesting. It shows the S&P500 P/E on an as reported basis from 1936. The average P/E over that 72 year period is 15.8x . The forecast P/E on an as reported basis to the end of 2009 is currently 24.3x times and out to December 2010 is just 19.9x. Hardly what you would call cheap.

Note in the chart above that the P/E stayed in a range between 8x and 22x for approximately 50 years. In the 90's and then 2000's P/E's got out of hand. If I put a graph up leverage ratios and corporate profits over the same period I think it is safe to say you would see the same trends.

If the leverage ratios of old are not coming back in the forseeable future then we are looking at a lower level of corporate profits and thus even with the S&P500 hovering around the 800 level, it is not yet pricing in that lower level of corporate profits.