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What's So Special About A 17x PE Multiple?

Tyler Durden's picture




 

Is there something particularly notable about a 17x trailing PE multiple on the S&P 500? According to Deustche's David Bianco, there is especially during mid to late cycle expansions, i.e., after three (or much more in this case with the S&P 500 now repoting 5+ years of EPS growth) years of rising earnings. In fact, as DB calculates, the only two periods of a PE over 17 after 3 years from the last EPS decline are 1965-66 and 1996-98 (Figure 2) below. And right now. It should be self-explanatory that both of those historic periods ended with a sharp equity correction.

So how does the German bank explain the current outlier phase? Simple: "long-term interest rates this low are more rare and support a higher PE." In other words, all those who scream bond bubble, are blissfully ignoring the fact that it is these low rates that are permitting the spin that allows already stretched equity valuation to get stretched-er and approach David Tepper's magical 20x as a "fair value" for stocks.

And the culprit at the bottom of it all? Why the Fed, of course, with its disastrous policies, because in a normal world, a 2.4% 10Y would signal an impending economic disaster, only this time it suggests, conventional wisdom "explains", a green light because there no longer is a market that can be taken at face value thanks to the Fed's endless manipulation of every single asset class.

In any event, back to the 17x PE and how one should read it:

Above 17 PEs are rare after many years of EPS growth, but very low interest rates are more rare and support higher PE

For the S&P 500, since 1960, the month end PE on 4qtr trailing EPS exceeded 17 in 42% of all months. However, most PEs at month end above 17 were after recessions when EPS was still cyclically depressed or after 4qtr S&P EPS declined outside of recessions such as in 1967, 1987, and 1998. It’s been 5 years since a US recession and 5 straight years of S&P EPS growth, the record stretch for EPS growth being 6 years from 1992-98. The only two periods of a PE over 17 after 3 years from the last EPS decline are 1965-66 and 1996-98. Thus, the PE is usually under 17 unless investors view EPS as below trend. But the PE was sustained over 17 on normal EPS from 1964-66 and 1996-2000, which represents a large but concentrated portion of mid-cycle years. The PE was a bit over 17 in 2+ years post recession briefly in early 1973 and mid 1987.

 

There are seven multi-year periods with PE above 17 (shaded in the table), while most of these periods were early to mid cycle years there were also the extended mid cycle years (5.5 years) of the mid and late 1960s, the 5 years of 1996-2001. These 7 periods with PE above 17 that lasted more than 1 year are relevant for helping determine the likelihood of today’s PE staying above 17 for an extended period. The 7 bolded periods are those with PE above 17 and are periods 2 years or more after recessions. The above 17 PE in these periods are not due to cyclically depressed earnings following recessions, and they are 20% of all periods.

 

So how does one justify this relentless multiple expansion? Simple: near record low rates, which in a normal world would presage a deflationary collapse which in turn would be extremely bearish for stocks. Only this time it's different.

Interest rates go in only one direction this year. Despite improved US growth trends, a tighter labor market and arguably lesser geopolitical risk, this week long-term treasury yields set lows for the year. Other than pointing to Europe’s inability to sustain growth and falling European yields, this persistent decline in treasury yields is astonishing. Although the uptick in labor force participation mitigates the risk of overnight rate hikes starting early next year, higher overnight rates are still on the visible horizon. Thus, powerful global structural trends appear at work and we find ourselves more accepting of long-term risk free real interest rates staying well below historical norms through the cycle. The completion of a good earnings season, improved confidence in decent US growth and S&P EPS growth for at least the rest of the year, and these still exceptionally low interest rates is shifting risk firmly to the upside for our longer-term fair value S&P 500 targets. We increasingly see the currently observed PEs as fair with upside at Tech, Healthcare and Financials, partially offset by Energy, with further overall S&P price gains fueled by EPS growth.

 

What is left unsaid is that the moments rates go up beyond the max pain point for algos and "risk parity" strategies, equities sell off and the proceeds go where? Right back into Treasuries whose sell off caused the equity sell off in the first place. Rinse. Repeat. Which just happens to be the closed loop that the Fed has created with 6 years of direct intervention, and whose breakage will be far less pleasant than its creation...

 

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Mon, 08/18/2014 - 12:45 | 5109265 LawsofPhysics
LawsofPhysics's picture

"Winning" -

(for the buy low, sell high, members of the club that "trade" on inside information and special access, there really isn't anything else to say)

 

Please idiot, what is "left unsaid" is that rates will never go up again, because there is no treasury "market"  price discovery on so many fronts is fucking dead.

tick tock on all fiat.


Mon, 08/18/2014 - 12:46 | 5109282 Duffy
Duffy's picture
A 17x PE Multiple?

 

doesn't that make your balls shrink?

Mon, 08/18/2014 - 12:47 | 5109285 Al Huxley
Al Huxley's picture

Forget about anything other than 'BTFD' corrections until the FED raises interest rates (never) or the USD collapses (inevitably, but who knows when...)

Mon, 08/18/2014 - 12:54 | 5109322 disabledvet
disabledvet's picture

Think Peak Bubble in the 90's was p/e of thirty.

You can't exclude dumb luck from the equation....though it can be hard to "quantify" (other than "I'm short this thing five years running now and all I do is cover.") Yellen's job is a total layup here..."stay the course on unwind of QE." Everyone else has the problems economically speaking...not that this still doesn't remain the worst post war recovery in US history. "That's a political question now" it would seem.

Mon, 08/18/2014 - 12:57 | 5109333 besnook
besnook's picture

it is different this time.  there has never been a time when inflation was almost exclusively in the realm of equities and other assets the .1% buy(including neiman marcus underwear). where else will they put their money if they bail out of equities? money market funds? there has also never been a time with such agressive intervention by the fed to the point that they will lose control of the chaos they created if the market tanks. there may be a correction but only as a head fake. btfd! the only other investment that can be made is short.

Mon, 08/18/2014 - 13:01 | 5109347 q99x2
q99x2's picture

It is FED software applications.

Mon, 08/18/2014 - 13:01 | 5109353 Mark_BC
Mark_BC's picture

And was the Fed buying stocks back then?

Mon, 08/18/2014 - 13:15 | 5109424 Quantum Nucleonics
Quantum Nucleonics's picture

The only thing more complicated that those charts is Deutsche Bank's (who made the charts) capital structure.

Mon, 08/18/2014 - 13:32 | 5109514 lasvegaspersona
lasvegaspersona's picture

dup

Mon, 08/18/2014 - 13:16 | 5109431 Stoploss
Stoploss's picture

"long-term interest rates this low are more rare and support a higher PE."

http://research.stlouisfed.org/fred2/series/DGS10  more rare Where??  

 

"Only this time it's different."    L!  LO!!   LOL!!!

Mon, 08/18/2014 - 13:19 | 5109444 CheapBastard
CheapBastard's picture

We've already seen several stocks correct considerably: RGR and McDs for example. There will most likely be much more pain for those who bought at the top. Plus, we still have the Housing Bubble Collapse in store for us.

Mon, 08/18/2014 - 13:19 | 5109445 digitalindustry
digitalindustry's picture

Buy Bitcoi....oh.

Mon, 08/18/2014 - 13:31 | 5109519 lasvegaspersona
lasvegaspersona's picture

As long as Bitcoin is fluctuating wildly I suppose some will enjoy and profit from speculating. In the end it is just a medium of exchange however so why not buy physical gold. Lately the price has been stable and it does have a bit of an historical advantage.

Mon, 08/18/2014 - 13:20 | 5109453 digitalindustry
digitalindustry's picture

Belgium will buy them !

Mon, 08/18/2014 - 13:28 | 5109498 lasvegaspersona
lasvegaspersona's picture

For the little guy in protective mode...gold with an S&P hedge makes sense...with enough cash for bills of course...

After 40 years of 'investing' I can't make sense of the market nor of what the experts say about the market.

Mon, 08/18/2014 - 13:29 | 5109510 XRAYD
XRAYD's picture

When have we had such earnings "growth" and p/es, with accounting gimmicks, money printing, and peoples savings - through retirement plans and finacial repression by the Fed supporting the markets?

If I recall history, it was just before Julius Casesar was murdered.

Mon, 08/18/2014 - 13:35 | 5109535 aztrader
aztrader's picture

Is that PE of 17 using GAAP accounting or non-Gaap accounting?  Looks like alot of companies are using Bernanke accounting today.

Mon, 08/18/2014 - 14:16 | 5109775 LawsofPhysics
LawsofPhysics's picture

Call it what it is, "mark to fantasy".

Mon, 08/18/2014 - 15:14 | 5110143 NEOSERF
NEOSERF's picture

Rates will never, can never be allowed to rise again...Yellen is simply waiting for the next crisis or downturn to turn on the spigots again...rinse, repeat.

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