Indeed. He has joined the camp of believers who thinks recovery would be in the form of the letter V. He came out today with a special report on this. By the way, V is not simply a reference to the direction by which recovery would happen. Instead V stands for valuation. And in the report, he did gave quite some fantastic numbers with regard to valuation. One can choose from three options – be it trailing P/E, forward P/E or P/BV.
On trailing P/E:
On an operating (“scrubbed”) basis, the trailing P/E multiple on the S&P 500 has expanded a massive 10 points from the March lows, to stand at 27.6x. Historically, when the economy is taking the turn away from contraction towards expansion, which indeed was the case in Q3, the trailing P/E multiple is 15x or half what it is today (and that 15x is also calculated off depressed earnings level of prior recessions – we have more on the historical comparisons below).
On forward P/E:
Bullish analysts like to dismiss the actual earnings because they are “depressed” and include too many writeoffs, which, of course, will never occur again. Fine, on a one-year forward (operating) earning estimates, the P/E ratio is now 16.2x, the highest it has been in nearly five years. During the last cycle, at the peak of the S&P 500 — October 2007 — the forward P/E was 14.3x and the highest it ever got was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment).
At the end of a given recession, the forward P/E multiple is closer to 14x or a good 15% lower than what we have on our hands today. As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the U.S. dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 7.0% clip and corporate profits were rising at over a 50% YoY pace.
And finally, on P/BV:
The price-to-book ratio for the S&P 500 is currently at 2.4x, which is exactly in line with the average of the past four decades. However, at the end of recession, the market is normally trading closer to 1.5x book. Moreover, as the FT recently highlighted, a fair-value price for the S&P 500, based on ROEs, P/Es and price-to-book ratios, would place the “equilibrium” level for the S&P 500 right now at 867, which means we do have potential for a 20% correction here.
Whatever way we look, there’s just seems nothing that tells us this rally (and maybe even the recovery) is genuine. In the same report, Rosie also spoke about a new paradigm, a recovery that is jobless. He points out that for a 60% rally such as ours at the moment, 2 million jobs should be created, not lost. So this doesn’t quite add up.