S&P500, what's a fair level?

Here’s something interesting, I took a deeper look at P/E history for the S&P500.

First, we need to get the real P/E , free from American statistical manipulation. Obviously forward P/E is a joke, they crank this up, then when the quarter comes they crank it down, so they can “beat expectations”…so only trailing P/E can be used. Second, we have to use as reported P/E , not the operating P/E which includes “analyst adjustments”. If you look at the difference between the two, as reported is going up faster than operating, I’m going to go ahead and assume analyst manipulation here – between manipulated “operations” and “forecasts” they can make this look at 15X with a little magic dust. And then of course we have financial engineering to make P/E seem lower, but I don’t have any way of backing that out. So, what does that give us… As reported P/E is currently 21.9X , but this is calculated before taking into account the negative earnings this quarter, it will be even higher once we close the earnings season. Looking back over the last 145 years, the average is 15.6X. Every time it approaches 23-25X it gets smashed down. Recent examples: Nov 2007 peaks 22.4X, Jun 1992 peaks 23.9X, Oct 1961 peaks 22.6X. The exception is Feb 2000 when it made it to 28.3X before the dobcom bubble burst!! So it’s definitely very high right now vs history, but as Chad pointed out, there is no time in history where rates have been zero for this long, so we could make the argument that this is some sort of “new normal” given cost of capital. Still, I am skeptical – US GDP growth won’t be going anywhere, global growth forecasts decreasing, earnings are negative, financial engineering, central bank tricks are unsustainable, recession expected in next three years, yet multiple continues to expand? Chart (remember you need to ignore post subprime and dotcom P/E distortions): http://www.multpl.com

Update: per S&P Senior Index Analyst, published Thursday close, the real P/E ratio is now 23.29X (earnings from real GAAP financial statements kids!). That’s with 88.5% of companies having reported earnings. Someone must have reported crap this week, because EPS crashed. The ratio has only been this high twice in the last 100 years, dotcom bubble, and 1992. Of course nobody in the finance sector will be mentioning this number…

Math = 2099.92 / $90.18 = 23.29.

Also an important fact from the same analyst: Q3,’15 buybacks continue, as the initial reports have Q3 33% higher than Q2,’15 and 6% higher than Q3,’14

http://kr.spindices.com/documents/additional-material/sp-500-eps-est.xlsx

More importantly: Inflation won’t be going anywhere. As long as inflation rates in EMU/US are so low rates are going to stay low. I’d ratherexpect a significant shift in Monetary Policy paradigms than an increase in policy rates. (Like in Sweden). There was an interesting article about Yellen’s rule of the FED in ‘the Diplomat’ this weak which discusses this issue somewhat.

As the guy who checks people’s math, I would like to point out that Bloomberg are blatantly manipulating statistics , again.


“On a share-weighted basis, S&P 500 profits were down 3.3 percent on year in the third quarter, marking a second consecutive quarter of negative earnings growth.” http://www.bloomberg.com/news/articles/2015-11-23/s-p-500-profits-fall-25-billion-in-first-three-quarters-of-2015


Wrong, Q3 earnings were down -14% YoY, marking a fourth consecutive quarter of negative earnings growth (per real math, which can be found in S&P’s excel download). Bloomberg share-weighted to get their number, which is NOT a proper method to use (explained by S&P here), and they did so in order to underrepresent the energy sector losses. Index earnings are simply the sum of the 500 earnings, period.

Shouldn’t Bloomberg and Factset math be illegal? This stuff happens prior to every crash, manipulating the numbers, like Fitch giving A ratings on CDOs. Out of 1000 investors, I’m probably the only guy who notices this stuff. That doesn’t really make it fair for the 999.

I remember this from 2008/09. Here’s Siegel (not that I subscribe to his views, necessarily) with a counter:

http://www.wsj.com/articles/SB123552586347065675

They should be made illegal because their earnings growth methodologies differ from yours?

a7eeae038851851a2b0507cca1917b04.jpeg (640×640)

Maybe you aren’t good with basic math. Well, you have a lot of company, especially in the USA! :wink:

Their “earnings methodologies” are picked from the available methodologies because they produce the most favorable result. The normal methodologies, which would generally be used if a source was objective, are ignored and those numbers NEVER quoted…they are intentionally hiding the real numbers from the public, to prop up markets (just as we saw with CDOs and other instruments in the past). And besides, the chosen methodologies and simply mathematically WRONG, as explained by S&P in the link above. It’s not okay, and anyone who passed quant should know this is a serious violation of what ought to be (but clearly is not), common math-ethics.

I am not that sure that this is the case in the US. Yes, headline CPI is close to 0 at the moment but this is due to the energy price collapse and this effect will diminish in the next couple of month…if WTI is stabilizing at the current level that is. Core CPI is close to 2% and Shelter is also strong. http://jeroenbloklandblog.com/2015/11/20/8-charts-to-show-inflation-is-not-dead/

You’re either a tool or frustrated with your positions. No (successful) trader complains about market methodologies they find to be wrong, they simply exploit them and keep quiet.

Clearly that is not correct, since I exist; I exploit industry propaganda and talk about it.

Go back to the CFA books kid; mutual exclusivity, ETHICS , quant, etc.

I don’t work for bloomberg nor use their data - completely irrelevant to me if their data is accurate or not.

More hot air coming from the Far East…

#ChineseAccounting

pa is the guy who thinks stocks are their most expensive at their troughs. hey pa, did you know that P/Es are their highest at market bottoms, not market tops? even if the trailing P/E for the last year spikes from 18 to 23, or whatever, this is because of an earnings trough and is not indicative of the next 50 years. you can’t say that earnings will continue to grow at some long-term rate if earnings just fell 25%. this is why we have an analyst community. to normalize earnings so that we can look beyond basic P/Es for investment purposes. normalized P/E is still around 18-20x.

Ummm… Is this true? You’re assuming at the bottom earnings have fallen more than prices in a correction? I don’t believe this to be true.

^For brief pockets of time (i.e., the quarters right after the bottom of the bag has broken), this is true. 2000-2001 and 2008-2009 are perfect examples.

#http://www.multpl.com

using the link as a hashtag… brilliant

It’s not “even if” or “whatever”, it is a quantifiable number and it happened, 23X as of Q3 per S&P.

Forward earnings from the “analyst community” are obviously nonsense. They have been wrong (massive high) over and over again and have zero credibility. These are finance sector employees, selling a product. The ONLY valid number is the earnings that actually happened (trailing, as reported). You then run your own REASONABLE forecast.

The fact remains, trailing P/E, for which we have a 100+ year history, is VERY high. I did more sorting thru data on this, excluding post-crash distortions, the current ratio of 23X has only been higher 3 times in the last 100 years. Dec 1921, Jan 1992, and the years leading into the dotcom collapse.

http://www.multpl.com

It’s called math. My figures are there to check. Your figures are nowhere, just hot air.

I used to believe that trailing earnings were the figures to use because they didn’t depend on partly subjective estimates of growth and market share and profit margin trends. But it turns out that trailing PE’s are one of the least correlated indicators of forward returns (not negatively correlated, just close to zero) in the short and medium term, and for the long term it turns out that they aren’t different enough from forward earnings to make much of a difference, because forward PEs still tend to herd around the trailing PEs with just incremental differences that don’t mean much for the long-term that you can’t already get from trailing earnings.

The PE has been above the long term average since the mid 1990s, with minor exceptions at the trough of the dot com burst and credit crisis. So one can wait an awful long time for PEs to revert, long enough that you can be out of business and/or dead by the time you’re right.

I agree that rising interest rates are a major headwind, but if they rise rapidly, then then there is a long time for prices to reset and then adapt, and if they rise slowly, then the biggest effects are likely to be in the begining because we are so close to the zero bound. All of this means that we could very well be in for a bumpy ride, but not that modest growth rates of equities are impossible.

If we assume that a PE of 22 goes down to something more like 18, then what’s required to get 3500 are total returns of more like 9.2% annually. That does seem like a bit of a stretch, but could be achieved with less growth if high inflation kicks in.

Drinking coffee and crunching numbers on Sunday morning; the fundamentals behind this bull market get worse the more I dig…

You never want me to find an error in your math, because if I do, I check EVERY number until I’ve nailed down the whole deal. What got me started on this S&P500 valuation project – if you ask 10 retail investors, and 10 professionals, “what are the earnings”, you’ll get 20 different numbers. That is a red flag. After a month of digging, I think I’ve taken this about as far as it can go. Here are the real numbers as a public service announcement. This is the most important post on AnalystForum this year dammit, so get a coffee, open Excel, reproduce the math, and make sure you know what you are holding if you own S&P500 stocks, there is a lot of statistical manipulation out there… ---------------------------------------- WHAT ARE THE REAL EARNINGS? Authoritative earnings are the key number we need for any model or valuation. If we start with a nonsense number, then all subsequent analysis is nonsense. So you can’t use numbers from “FactSet”, Reuters, Bloomberg articles, WSJ, etc…those are all made up numbers. We can put all the confusing numbers out there into categories… 1) “Operating earnings” or “adjusted earnings” are bullshit numbers. There is no standard, different companies and analysts make different adjustments, not only are they inconsistent by company, but they are inconsistent over time for the same company. If you start with these earnings as your base, you can’t compare to prior periods, nor use the 100yr history. Plus the spread between these numbers, and the official GAAP numbers, has been increasing since the start of this bull market. A huge red flag. 2) “Forward earnings” are bullshit numbers. These are always unbelievably high, and are adjusted down right before actuals come in, so they can “beat expectations”. Forward earnings, and the expectations created by them, shared by companies like “FactSet”, are useless…notice that these companies are careful to never quote trailing as reported earnings, ever. 3) “Share-weighted earnings” are bullshit numbers. The proper way to calculate any S&P500 index earnings-related number is [aggregate earnings for quarter / divisor]. Example Q2 '15 was $201.4B as reported earnings / 8831 divisor = $22.80 EPS. Let’s say Exxon reports a $10B loss, that is an absolute value, their size is already accounted for, you as an index holder take that loss. If you weight earnings to make the losses look smaller because energy is a smaller sector, like Bloomberg does, you are making up fantasy numbers…this is simply mathematically wrong. Weighted earnings: they don’t add up… and you may get burned (by S&P) 4) “As reported earnings” are the real GAAP earnings reported in the financial statements. Everyone follows the same rules (more or less), or they go to jail. These are written in stone; once they are reported, that number to the penny will never change. It’s the best we’ve got. They are reported by S&P labeled “as reported trailing twelve month EPS”. That is our authoritative earnings number; GAAP data as crunched by S&P’s senior index analyst Howard. Q3 EPS (ttm) = $90.85, 23.0X as of Nov27 '15. Any future earnings will eventually become these trailing GAAP earnings, until that happens, it’s all fantasy. If you need to forecast, use as reported trailing as your base, and generate your own REASONABLE forecast on that. ---------------------------------------- EXAMPLE OF NONSENSE EARNINGS Q3 (ttm) EPS from S&P are: as reported $90.85 , operating $104.14 , forward+operating $122.35. Forward-operating is absurd of course, but it is how they keep telling the noobs that it’s cheap P/E 17X instead of 23X. Other companies use different operating/forward numbers than S&P, Reuters estimates differ dramatically, so none of this will ever tie out. As reported is the only solid base. ---------------------------------------- BUYBACKS, A COMPLICATION We’ve still got a major problem with using trailing as reported EPS as the driver for our models and valuations though; it is manipulated by corporate America by tweaking the denominator. You can download buyback data from S&P, I modeled it this morning. Roughly speaking, as reported EPS without the last 5yrs of buybacks, would be more like 83. So P/E isn't 17X fantasy-forward, and it isn't even 23X trailing, it's more like 25X. [Bloomberg on buybacks](http://www.bloomberg.com/news/articles/2015-07-16/corporate-stock-buybacks-make-earnings-look-better) ---------------------------------------- **SO WHERE DID RETURNS COME FROM IN THIS BULL MARKET?** Disaggregating the S&P500 5YR total return, step by step, nailing it the f@# down to authoritative S&P data. Check it out yo… 5YR TOTAL RETURN 15.3% CAGR** = EARNINGS GROWTH 2.5% + BUYBACKS 2.3% + DIVIDENDS 2.4% + MULTIPLE EXPANSION 7.7% [ERROR 0.4%] Q3 2010 to Q3 2015 TR as calculated by S&P (plus adding on the index appreciation to Nov27th, ending value of 2090). In order to nail this down, we have to realize the 5YR 4.8% EPS (ttm) growth rate from $71.86 to $90.85 is partly buybacks. Aggregate as reported earnings grew from Q2 2010 $178.0B to Q2 2015 $201.4B, a 2.5% CAGR (Q3 is not available yet). Which means the 4.8% EPS growth = 2.5% earnings + 2.3% buybacks (roughly, this is hard/impossible to get perfect). Crosschecking this confirms we are close; S&P reports the Q2 (ttm) buyback yield was 3.0%, and Bloomberg reported buybacks added 2.3% to EPS growth in 2014 (link above). Since we know total return and dividends, and now we know earnings and buybacks, the remaining return is multiples. We can cross check this; P/E expanded from 15.9X at the start of the period to 23.0X, a 7.7% CAGR. I have a 0.4% error which showed up when I started trying to break out buybacks, so either earnings growth or buybacks must be understated. ---------------------------------------- BULL MARKET SUMMARY S&P500 companies are only doing ~2.5% earnings growth for the last 5yrs**(which after inflation of 1.7% is only 0.8% real earnings growth). They aren’t investing in the future, they are currently paying out more in buybacks+dividends than they actually make in earnings…essentially liquidating their companies (we saw this is late 2007 also). Over the last five years there is a10% annual return from buybacks and increasing valuations, both of which were fueled by ZIRP/QE, and are unsustainable. That’s a fragile starting place for a 10-yr forecast: risk of multiple contraction, earnings recession due to lack of investment, increased share issuance (reverse of buybacks) or increased debt expense as rates raise. Don’t say I didn’t call it hommies, and remember I called subprime in Q4 '07 also. Timing is hard, but this game is approaching check-mate. The math hits a wall. SOURCE: S&P, http://www.spindices.com/indices/equity/sp-500 “additional info” dropdown, Excel download: “index earnings”, “stock buybacks”, “monthly and annual returns”. Pull more history from http://www.multpl.com (Josh uses S&P’s numbers too, with a philosophy of “just the facts no spin”, I’ve spot checked his math, never found an error, that’s rare for me).

fyi, noobs never see forward earnings. and bchad is right that forward earnings are more telling than trailing earnings because of the effect of write-offs and the fact that earnings declines are always temporary.

all i hear when you defend your stance is that you think the worst times in history to buy stocks was March 2009 and early 2002. because that’s what you’re arguing.