Rosenberg is going bald from all the headscratching that is going on with equity valuations. And yes, we have dissected the 10 Year to Stock correlation before, and have concluded that the fair value of the S&P with the 10 Year here is in the mid-700 range:
The consensus has certainly taken down its numbers on profits and on the economy, but by not nearly enough. The consensus of equity analysts still sees 13% growth in operating S&P 500 EPS for the coming four quarters, even though the math does not work at all. For one, margins have already very rapidly expanded to cycle highs. This means that there is very low potential for profits to grow much in excess of nominal GDP growth, which, at best, will be low single digits. That would put EPS for the next year closer to $80 than the $88 consensus forecast and place the forward P/E closer to 13x than 12x (it is 12x on consensus view). Of course, if the economy does double-dip, then we are talking about EPS going down closer to $60 if the historical pattern during downturns reasserts itself, which then means the forward P/E multiple is really north of 17x.
This is why valuation is so tough — beauty is in the eyes of the beholder. Historically, the forward P/E with consensus estimates is 15.6x, and yet if you look at what we actually end up with, it is 19.2x. So the consensus is always publishing an earnings forecast that makes the market look cheap! And, this “bias” is close to 20%, on average. We still prefer the Shiller P/E, which uses the ‘bird-in-the-hand’ earnings, takes them in real terms, and cyclically-adjusts the earnings data, and the multiple here is 20.6x, which is 26% above the historical norm. So sorry, the only way you can get this market to show that it is “attractively” priced is to rely on consensus earnings projections, which by the way, are coming down but still too high.
Ditto for consensus real GDP growth, which sees 2½% growth for Q3 and Q4. It is not going to be too difficult to see flat to negative prints for both quarters barring some massive positive exogenous shock.
As for 2011, the consensus is at 2.8% for real GDP growth. Are you kidding me? This is a reason to start going the other way on a contrarian bet? You must be joking. When the sign on that 2.8% changes from a plus to a minus, dial us up.
So, with earnings estimates still +13% for the coming year and consensus GDP forecasts lowered, but still well above 2%, then it is hard to build the case that we have seen anything near full capitulation. Not only that, but equity fund managers are only sitting at 3.8% cash ratios — in the 2001 and 2008 downturns, these ratios got as high as 6%. Now that is capitulation and we are not there yet.
Plus, keep in mind that we are in a secular bear market, which is constantly peppered with flashy rallies and significant setbacks. Japan, for example, has just posted its fourteenth(!) 20%-plus decline in the Nikkei index since the peak was turned in 21 years (and 77%) ago!
And for those position short, and betting on the Hindenburg to make their year, that possibility is getting ever more distinct:
We understand that Mr. Market has drawn 1,040 as a line in the sand but if that support level breaks, as the comparable level did in Japan in the past week, then it seems prudent to take out some insurance against a fall-time fall-off of significant proportions. Those with cash on hand as a tactical asset would seem to be in pretty good shape in terms of taking advantage of what seems to be a very strong chance of sustained selling pressure, especially upon a break of key technical levels. The Fed may well come in with another round of QE (can it really do this with a published 3.5-4.2% GDP growth forecast for 2011?), and the White House may yet see the light and delay the tax hikes (what happened to the campaign pledge of income redistribution?), but these policy shifts would only take place if recessionary pressures were to intensify, which in turn would dramatically cut earnings expectations. The actions themselves would only end up smacking of Japanese-style desperation — hence any policy-induced rallies would probably only represent an opportunity to reduce exposures at better price points. This bear market rally ended in April (confirmed by three failed tests of the 200-day m.a. in the S&P 500 since the nearby peak four-months ago), and amazingly, those who see it that way are still in a minority — institutional portfolio manager cash levels are still very low at 3.8% and susceptible to stepped-up outflows.
In other news, we are still loving us some Nikkei-SPX convergence.