Thursday, September 27, 2012


So what is the correct P/E for the S&P 500? Our “Blue Angels” analysis of earnings momentum and valuation shows that 13 has been an unlucky number for the P/E for the past three years. The rallies of 2010 and 2011 were followed by nasty corrections after the P/E rose to 13. On September 14, the P/E was back just above this jinxed level. Now it is just a bit below it.

Then again, I’m hearing more folks in our business talking about the “Rule of 20.” Stocks are deemed to be cheap (expensive) when the sum of the P/E and the CPI inflation rate is below (above) 20. The CPI was up 1.7% y/y during August. Using the S&P 500’s forward P/E, the sum of the two was only 14.4 during August, suggesting plenty of upside for the valuation multiple. In my opinion, while the Rule seems to work at extremes, it isn’t a sure way to determine where the P/E is heading next most of the time.

I suppose that the actual implementation of open-ended quantitative easing by both the Fed and the ECB could lift the P/E above 13 to 14 by the end of the year. If forward earnings rises from 112 now to 115--equaling the current consensus forecast for next year (assuming that doesn’t change)--then the S&P 500 has the potential to rise to 1610 by the end of the year.

I think that’s not likely to happen until we see how the US elections play out. That will influence how Washington deals with the fiscal cliff, which will certainly result in a US recession early next year if Congress remains gridlocked. In addition, mounting social unrest in China and Europe are also weighing on the outlook for global economic growth next year. Oh, and then there is all the commotion in the Middle East. These uncertainties are likely to keep a lid on valuation for a while.

Today's Morning Briefing: Social Unrest & Valuation. (1) Plosser is skeptical about QE3. (2) Caterpillar is cautious about the global economy. (3) Remarkable resilience in earnings expectations. (4) The number 13 has been unlucky for P/E over the past couple of years. (5) The case for 14. (6) The case against the “Rule of 20.” (7) Lots of headlines about social unrest in China and Europe. (8) What’s the impact on valuation? (More for subscribers.)


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