All-Over-Map Valuation Models Thwart Unified Stock-Market Thesis

(Bloomberg) — Scarily expensive, or dirt cheap? Cross-currents in the stock market’s $15 trillion wipeout are making it harder than ever to get a grip on valuations.

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The S&P 500, even after a 21% drawdown this year, remains near or way above levels seen during the dot-com peak when plotted against sales or tangible assets. It altitude gets easier to justify versus earnings — as long as earnings are real. Move down the ladder to smaller companies, and many stocks can be framed as bargains.

Like everything else, the market in the post-pandemic era has defied old-school analysis, as unprecedented monetary easing and its unwinding speed up the economic cycle. A typical view is held by Leuthold Group, the Minnesota-based money manager: valuations have fallen with almost unparalleled speed, but were so high to begin with that they remain way above where past routs ended.

“The decline in P/E ratios during the bear market has been impressive — but that’s in part because the ‘starting point’ was so extreme,” said Doug Ramsey, chief investment officer at Leuthold. “Bulls who reminded investors throughout the climb higher that ‘valuation is not a timing tool’ have been too quick to forget their own good advice on the way down.”

The correction in valuation has indeed been fast. After falling in 10 of the past 11 weeks, the S&P 500 hit 18.3 times profits, down from a peak ratio of above 30 last year. The 43% drop in P/E over the stretch almost matched the size of the contraction during the entire 2000-2002 crash.

As things stand, a case could be made that stocks are reasonably priced now, with the index valued at 15 times next year’s profits, now estimated at $249.1 a share, according to analysts tracked by Bloomberg Intelligence. On the other hand, should the economy slip into an recession, as many economists and business leaders believe it will, the reliability of those estimates would diminish greatly.

A scenario analysis by DataTrek Research shows that if a recession is avoided, existing earnings estimates point to an possible target of of 4,100 for the S&P 500. If not, 3,300 could be on the horizon. The index was little changed at around 3,770 in mid-morning trading in New York Wednesday.

“Think of US stocks as being like a seesaw,” said Nicholas Colas, co-founder of DataTrek. “And today’s prices essentially reflect equal odds (a horizontal plank) of near-term corporate earnings power increasing or decreasing by 10%.”

Other yardsticks are less kind, including price-to-sales. The S&P 500 trades at about 2.3 times the combined revenue of its constituents. While partly a consequence of fattening profit margins, the multiple is about the same it was at the height of dot-com mania.

To Matt Maley, chief market strategist at Miller Tabak + Co. a gauge based on the top line offers a more accurate indication on market valuations.

“Earnings can be manipulated through charges, etc. However, sales are sales. Unless the company is outright lying, you cannot play with sales numbers,” Maley said. “When the price-to-sales number is sitting at basically the same level it did at the tech bubble high, it’s very hard to say that the stock market is approaching ‘fair value.’”

Another worrying chart compares share prices against physical assets. With the S&P 500 trading about 12 times its tangible book value, the multiple is roughly 30% above what it was during the internet-bubble peak.

While higher than other indicators, it’s also easier to explain away in an era when investors place a premium on intellectual property and less emphasis on plants and equipment. The trend accelerated during the pandemic lockdowns, when factories were shut down and consumers shifted their spending online, sending intangible-heavy firms skyrocketing.

Has sentiment been washed out to signal a bottom? Probably not, according to Chris Verrone, head of technical analysis at Strategas Securities who studied past routs and found that a floor usually forms after the largest stocks succumb to panic selling.

During the carnage last week, trading in Apple Inc. shares was subdued. With a P/E ratio of 21, the stock was valued above the multiple of 18 it fetched at the end of the 2020 crash and the reading of 12 after the 2018 selloff.

“In 2008 it was Exxon and Walmart where volumes surged in the final innings of the decline, and in 2002 it was Cisco,” Verrone wrote in a note to clients. “It hasn’t happened today with Apple, yet.”

Yet bargains have started to surface in some corners of the market, such as smaller firms. Take the S&P Midcap 400 Index. At 13.9 times profits, the index trades at a multiple that is close to the lows reached during the pandemic crash and the 2008-2009 financial crisis.

The same is also true for the S&P Smallcap 600 Index, whose P/E at 13.5 now is cheaper than any time since 2009. And after trailing large-caps for four straight quarters, small-caps have outperformed since March.

“The idea that small caps may already be reflecting a recession and appear to be stabilizing relative to large caps is something all investors should take note of,” said Lori Calvasina, head of US equity strategy at RBC Capital Markets LLC. “Small caps are often viewed as pure plays on the domestic economy and tend to be viewed as leading indicators.”

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