Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: With the S&P 500 up over 13 percent in just the first four months of 2013, and breaking into new all-time highs on a seemingly daily basis, it’s fair to wonder if stocks are currently overvalued. You tackled that question in this week’s Sector Watch by looking at the S&P 500 from various earnings perspectives. What did you find?
Stovall: I found that the market is still trading below its longer-term averages, whether you look to trailing or projected earnings, and whether you look to operating earnings or GAAP (as reported) earnings. Specifically, I found that that S&P 500 is trading at an 11-percent discount to the average projected 12-month P/E on operating earnings since 2000, and would be trading near 1820 if its multiple equaled the 13-year average of 16.2.
Even at a more subdued P/E of 15 times projected 12-month earnings, the S&P 500 would be a good 50 points or so higher than where we are right now. Even using the more inclusive 12-month GAAP earnings, which includes writedowns for discontinued operations, etc., the S&P 500 is trading at a multiple of 18.3, which is an 8-percent discount to its 25-year median.
Finally, the current trailing GAAP P/E is 7 percent below the average of 20 times, which was seen whenever inflation has been in the second lowest quintile as it is today since 1948. That’s a lot of numbers to throw at you, but basically, whether you look at projected or trailing results, and whether they happened to be operating or GAAP, the same answer comes up: We’re trading at a discount in the high single digits or in the low double digits.
EQ: Looking down to the sector level, you compared current trailing P/E ratios to historical norms. Were there any that stood out to you for one reason or another?
Stovall: Yes, if you look specifically to the median absolute P/Es—meaning, the current P/E versus the sector’s history—I found that the cheapest one is Technology, which is trading at a 39-percent discount to its absolute P/E. However, a possible reason for this could be that it had such a tremendous P/E in the late 1990s, and that sector history only goes back to 1994.
Another area that’s showing a pretty steep discount is Health Care, which is showing a 23-percent discount.
On the flipside, we see that Telecom Services and Utilities are trading at pretty hefty premiums to their long-term averages. Telecom is trading at a 25-percent premium to its long-term average, and Utilities is trading at a 16-percent premium. All of this is happening against a backdrop of a market that, itself, is 15 percent below its quarter-century average.
Taking this one step further, I looked at how they compared on a relative P/E basis—in other words, are these sectors cheap or expensive when compared with the market? We find that Technology and Health Care come up once again as being relatively attractive versus the market. Also, we find that Telecom and Utilities are very expensive versus the S&P 500. So it’s interesting to be able to look at the valuations underneath the surface to see which sectors look cheap or expensive.
EQ: Looking at the overvalued and undervalued sectors, it kind of supports our previous conversations of investors flocking to the yield-paying sectors.
Stovall: They had been, up until the last couple of weeks when investors got the idea that the payroll data would end up being relatively strong. Once they received that confirmation last Friday, they have been gravitating toward the cyclical sectors because the P/Es were so low. At one point, the P/E on the defensive sectors was 17 on average, versus 13.5 for the cyclicals. So whenever opportunity presents itself, investors usually take advantage of those opportunities, as they have most recently.
EQ: Considering that earnings have kept pace with the astronomical returns during the current bull market and in recent months, is the market actually healthier than it gets credit for?
Stovall: That’s a fair statement, because even though the U.S. economy is growing more slowly than it normally does in the fourth year of an economic expansion since World War II, our estimate is for a 2.7-percent increase in real GDP. That actually points to a 7-percent increase in earnings, which Wall Street is now looking for. I think that people are assuming that things are really bad, and all that is happening is company management is engaging in a lot of accounting shenanigans and sleights of hand like share repurchases.
I would tend to say, however, that the earnings are actually coming in line with history, and looking better than one would think. I would just like to see revenues actually climb along with the earnings, because even though we’re seeing earnings up 5 percent for the first quarter of 2013, versus the estimates of 1.5 percent at the beginning of the quarter, revenue growth has actually declined. It was expected to be at 4 percent, but now expectation is for revenues to only be up 1.5 percent.
EQ: How does this current bull market compare to previous ones in the S&P 500’s history, just from a performance standpoint?
Stovall: Well, we’re up 140 percent in these first four years of the bull market, which has actually been pretty strong when compared with history. When you look at a chart, we experienced pretty much a V-shaped recovery that we mapped out since bottoming back in March 2009. However, I think what’s interesting is that the long-term average increase for the S&P 500 is 13 percent, and right now, we’re at the very beginning of the fifth year of this bull market, but when you look back to years two through four, the average gain was around 13 percent.
It was just that the first year was so strong. Normally, since WWII, we are up 38 percent for first year of a bull market, but we were up 69 percent. So year one was the outlier, whereas year two, three, and four were pretty much equal to history. So I would tend to say that we are above the longer-term average for bull markets thus far in.
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