Jan 25, 2016 | Post by: Roman Chuyan, CFA Comments Off on Stocks Remain Overvalued

Stocks Remain Overvalued

The 7% drop in the S&P 500 this month was significant by some measures. For example, investor sentiment moved to levels of bearishness rarely reached since the financial crisis: AAII’s individual investor bear/bull ratio stands above 200%, an extreme level of negativity rarely seen outside of 2008-09. But, how much did valuation really improve? Not really much in mid-term context – while the P/E Ratio eased to 18.5 from 19.6 on Dec 31st, it remains significantly above its 10-year average of 16.3 (see chart below).

SP500 PE Ratio - tactical investment management

The market must also deal with a new reality of declining earnings. Adjusted earnings declined year-over-year in both Q2 and Q3-2015 by about 1%, the first consecutive decline since 2009. Earnings are expected to decline again in Q4 by 6% YoY, according to Factset. Earnings will be higher by 2-3% when everything is reported, so they will likely show a 3-4% drop in Q4.

Similar to earlier in 2015, the estimated drop in Q4 earnings is driven primarily losses in the Energy sector. But weakness is not limited to the Energy and Materials sectors. Six out of ten S&P sectors are expected to report a decline in earnings, including significant declines in the Technology (-5.7%) and Industrial (-4.7%) sectors (see chart).

I should also note that these non-GAAP earnings are adjusted to exclude expenses that are deemed to be “extraordinary” by reporting companies; net GAAP earnings dropped by at least 15% YoY in Q3 and Q4, according to Standard & Poor’s.

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