Adam Oliensis Rational Market? 1/18/2008 3:41 PM EST The consensus is now calling for $100.32 for 2008 earnings for the SPX (as published at Standard & Poors). That makes the PE on forward earnings about 13.25, a new 12-year low. The earnings yield (the inverse of PE) is now 7.58%. The 10 Yr Treasury is yielding 3.648%. That makes the Equity Risk Premium (ERP) 3.93% (SPX forward yield less 10-Yr treasury yield = Equity Risk Premiim). Or, put differently, investors are demanding more than double the yield from stocks that they demand from 10-Yr Treasuries. Even if the consensus is off on earnings estimates by a factor of 2 -- even if the SPX earns just $50.16 in 2008 -- the market is merely "fairly" priced according to historical norms. (Historically the forward yield on the SPX is very close to equal to the 10-Yr Treasury Yield, though the 2 series can diverge for periods of years.) The last time Equity Risk Premium was this high (the last time stocks were yielding this much more than bonds)? May of 1980, when the SPX was about to rally from 104 to 135 by year-end. Of course, in the short term the "Get me the heck out of this market" trade can prevail for longer than is rational. But according to both technical and valuation models, this market is presenting itself as very similar to prior mid-term buying opportunities. Hmmm.....mid term buying opportunities....?
I'd wait with buying. I will wait till earnings yield is at 9% and the ten year yields 1%. At this rate we'll be there in a week or two
Thats all well and good and if you can guarantee me that those estimates wont get slashed by 40% then the market is a screaming buy. Unfortunately if this recession or slowdown is as bad as feared, we have absolutely no way of knowing what the ultimate earnings will be. IBM and GE were very solid with guidance but the market just doesnt believe them. Very difficult environement to make sense any further then a 5 minute bar.
The correct number is $83.70, not $100.32. http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS