One of our intermediate concerns about equities involves valuations. While we recently made a short term buy call, that is merely a trade that could possibly run for a couple of weeks or months — but not much longer. That call certainly wasn’t made because stocks are such screaming bargains.
As to valuations: Its hard to really say that stocks are cheap here. At best, I believe we can argue that — assuming that historically high earnings do not fade — that stocks are not terribly expensive. But that is very different than saying they are cheap.
Have a look at this lovely table from Dow Jones Market Data Center:
Stocks Are Not Cheap
You can also see the Yields On Dow Stocks here (Thanks, Tim!)
These are not the sorts of valuations you find at the end of Bear markets. And, James Montier points out a factoid that makes the above even worse: Analysts lag reality. James adds the damning observation that "They only change their minds when there is irrefutable proof they were wrong, and then only change their minds very slowly."
Have a look at his chart below: It is a linear time trend out of operating earnings and the analyst forecasts of those earnings (so the chart simply plots deviations from trend in $ per share terms).
As the red line in the chart shows, the earnings recession is just now beginning. But as the black line reveals, analysts have yet to lower their earnings numbers. Montier notes that the downgrading of estimates has been highly constrained to the financials (and to a lesser extent the consumer sector in the US for 2007).
Roughly speaking US earnings ex financials have been revised down by 1.5% compared to nearer 4% for the market as a whole.
Thus, our contention that markets have only priced in a short, shallow recession . . .
Asleep at the wheel, or, How I learned to stop worrying and love the bomb
Apr 07 2008, 02:52 PM
Schwab Asks Who Needs Analysts After Biggest Flub
Michael Tsang and Eric Martin
Bloomberg, April 7 2008