It's been quite a year for David Kostin and his flip-flopping Goldman equity strategy team. From a modest 1,900 year-end target in January (reached in May) [6] to warning stocks are 30-45% overvalued in January [7] to projecting the S&P 500 will reach 2,050 by year-end in July [8]...Mission Accomplished today, 6 weeks early. Now what?
Mission Accomplished...
[9]
Just ignore his warning in January... [7]
The current
valuation of the S&P 500 is lofty by almost any measure, both for
the aggregate market as well as the median stock: (1)
The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4)
EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE
and P/B relationship; and compared with the levels of (6) inflation; (7)
nominal 10-year Treasury yields; and (8) real interest rates. Furthermore,
the cyclically-adjusted P/E ratio suggests the S&P 500 is currently
30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.
Reflecting on our recent client visits and conversations, the biggest surprise is how many investors expect the forward P/E multiple to expand to 17x or 18x.
For some reason, many market participants believe the P/E multiple has a
long-term average of 15x and therefore expansion to 17-18x seems
reasonable. But the common perception is wrong.
The forward P/E ratio for the S&P 500 during the past 5-year,
10-year, and 35- year periods has averaged 13.2x, 14.1x, and 13.0x,
respectively. At 15.9x, the current aggregate forward P/E multiple is
high by historical standards.
Most investors are surprised to learn that since 1976 the S&P 500
P/E multiple has only exceeded 17x during the 1997-2000 Tech Bubble and
a brief four-month period in 2003-04 (see Exhibit 1). Other than those
two episodes, the US stock market has never traded at a P/E of 17x or
above.A graph of the historical distribution of P/E ratios clearly
highlights that outside of the Tech Bubble, the market has only rarely
(5% of the time) traded at the current forward multiple of 16x (see
Exhibit 2).
The elevated market multiple is even more apparent when viewed on a median basis. At 16.8x, the current multiple is at the high end of its historical distribution (see Exhibit 3).
The multiple expansion cycle provides another lens through which we
view equity valuation. There have been nine multiple expansion cycles
during the past 30 years. The P/E troughed at a median value of 10.5x
and peaked at a median value of 15.0x, an increase of roughly 50%. The
current expansion cycle began in September 2011 when the market traded
at 10.6x forward EPS and it currently trades at 15.9x, an expansion of
50%.
[10]
* * *
