NEW YORK: Given that US stocks have rallied nearly 60 percent in just six months, you’d expect valuations were getting a
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bit prohibitive.

But the resiliency of the latest rally shows that investors are unfazed by the market’s current multiples, regarding stocks as still relatively cheap.

With interest rates close to zero, earnings expected to improve in the third quarter, and inflation subdued, stock market bulls have much working in their favor, making it likely that the market will rise further in the next six months.

The Dow Jones industrial average is nearing 10,000, a far cry from its closing low of 6,547.05 in March. The benchmark S&P 500 .SPX — up nearly 19 percent year-to-date — has its sights set on 1,100 after closing at a 12-year low of 676.53 in March.

Low interest rates have revived the argument prevalent during the ‘Goldilocks’ period of the late 1990s and middle of this decade justifying higher valuation for shares.

“Stocks do remain relatively cheap,” said Philip Orlando, senior portfolio manager at Federated Global Investment Management Corp in New York.

“Multiples right now are probably around 16 times forward earnings. But because we are looking at very low core inflation, roughly about 1.4 percent, and 10-year Treasury yields below 3.5 percent level, we can justify multiples that approach 20 times.”

The current S&P 500’s forward P/E implies $66.83 earnings per share, based on individual estimated operating earnings for the 500 companies. Back in early March, the S&P 500’s forward P/E was about 11 times, which was below the historical average of 16 times.

Also working in the bulls favor has been the market’s ability to rebound from every attempted sell-off since the start of the runup. That development, analysts say, also shows that investors were willing to use dips as opportunities to get into the market.

BETTER ECONOMIC OUTLOOK

To get an even more optimistic picture of how far the market has come, some analysts point to the S&P 500’s trailing price-to-earnings ratio, based on past 12 months operating earnings.

That measure is at 20.6 times, up from 11 times in early March, according to Thomson Reuters data. That figure implies total trailing S&P 500 earnings of $51.97 per share.

“I don’t think the market is overvalued,” said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co. in San Francisco.

“The economy is doing better than expected and gross domestic product is going to reflect that and profits are going to reflect that. The market was not adequately pricing in the strength of the third quarter,” he added.

SEPTEMBER CURSE

Even the traditionally tortuous month of September, which has historically opened the door to seasonal weakness for stocks, is proving to be a banner time for the bulls, with the S&P 500 making a run for its best September in 11 years.

“One of the bearish arguments is that the gain in prices has made the market expensive, which of course suggests it was inexpensive six months ago, so why didn’t they buy then?,” said Laszlo Birinyi, founder and president of market research firm Birinyi Associates, based in Stamford, Connecticut.

Earlier this month he studied the market’s 25 leading percentage gainers since the March bottom — including Google Inc, Merck, Apple Inc and General Electric.

His study showed that if the leaders were to return to 2007 multiples and the rest of the list followed suit, that argues for another 33 percent gain in the S&P 500 to the 1,394 level.

“We are not insisting or forecasting that level, but would suggest that the contention that the market is expensive is – financials excepted – not necessarily the case,” Birinyi said in a note.

But not everyone is convinced that the market isn’t overstretched, with the S&P 500 at the farthest it has ever been above its 200-day moving average in more than 20 years.

“Too many cheerleaders are suggesting that the ‘September curse’ is broken now that equity indices have continued to climb even as the critical tests will come around the pre-announcement and earnings reports period that tends to start in late September leading into mid-October,” said Tobias Levkovich, Citigroup’s chief U.S. equity strategist.

The trailing P/E is a “distinct negative,” he said, noting that since 1940, when ratios reach such lofty heights, the market has posted negative performances in the next 12 months.

Admittedly, stocks still climbed rapidly in 1999 when the multiple was similarly north of 20 times, but that did not end well either.

source: Economictimes

Tags: expert views on markets, market outlook, nse bse market tips, stock markets

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