May 2 (Bloomberg) -- Have you heard about this poor beached whale up in Canada that has gotten all the blogs so excited?
As the story goes, the process of decomposition inside the dead blue whale is causing gas to build up in its carcass, inflating it like a giant balloon. The concern is that a tiny disturbance, or maybe nothing at all, will cause it to explode and send a hard rain of rotting blubber and assorted whale bits falling upon a sleepy Newfoundland village.
Alarmingly, some market observers with bold-faced names are viewing U.S. stocks just as suspiciously. They warn that valuations are filled with gas and a tiny disturbance, or maybe nothing at all, will cause the bubble to explode and rain bits of rotting equity blubber all over the nation’s sleepy long-only portfolios.
Tom DeMark, who created a bunch of complicated technical indicators and named them after himself, sees a chance the S&P 500 will drop 11 percent starting as soon as next week. His horoscope hinges on a punchlist of various levels being reached, and if you’re interested in the details you should read Joe Ciolli’s interview with him.
Jeremy Grantham, chief strategist at Grantham Mayo Van Otterloo & Co., said, in effect, the belly of the S&P 500 will fill up with about 20 percent more gas before exploding after the next U.S. presidential election. (Makes you wonder who the heck he expects to win the election?)
Still, just like with the Canadian whale, there are those who believe any excessive gas will simply leak out on its own rather than causing a massive explosion in the entire market. That may already be the case with the wheezy noises heard from the Russell 2000 Index and Nasdaq Composite Index, which are down 6.1 percent and 5 percent respectively from their March peaks.
By monkeying around a bit with Excel, you can compare valuations based on trailing earnings with ratios based on projected future earnings and start to see some spots where the valuation gas may be able to resolve itself on its own. (It helps to view the market as a collection of many beached dolphins instead of a giant whale in this exercise, though for fish lovers it may be a difficult vision either way.)
Topping the list is Health Care REIT Inc., a real-estate investment trust that invests in medical and senior housing properties. With a trailing P/E of about 676 you may be tempted to yell “thar she blows!” and run for cover. However, its valuation based on its estimated earnings over the next 12 months comes back closer to earth at 71. That’s still a pretty high ratio, but certainly not as alarming, and the difference between the two is the biggest among S&P 500 companies.
Three other REITs -- Equity Residential, Vornado Realty Trust and Crown Castle International Corp. -- are in the top 10 of S&P 500 companies with the biggest spreads between trailing and forward P/Es. This is not too surprising, given that real-estate companies are projected to increase earnings by 19 percent in 2014, second only to chipmakers among 24 industries in the S&P 500. (True wonks may prefer to value REITs based on funds from operations instead of earnings-per-share, but that disallows an apples-to-apples comparison.)
Elsewhere among the top ten with the biggest spreads between trailing and forward valuations are some of the usual suspects that have been hit with the heaviest selling from the recent rotation out of growth stocks: Electronic Arts Inc., Amazon.com Inc., Vertex Pharmaceuticals Inc., Netflix Inc. and Adobe Systems Inc. each show up with multiple spreads of at least 68.
Interestingly, the bottom of the list is similar to the top, with REITs Boston Properties Inc., Macerich Co. and Prologis Inc. topping the ranks of stocks whose valuations show they are more expensive based on future earnings than past. They are in the minority: all told, there are 413 stocks in the S&P 500 that are cheaper based on forward earnings estimates than in-the-book results.
As for that Canadian whale, has anyone tried a whale-sized dose of Mylanta?
To contact the reporter on this story: Michael P. Regan in New York at firstname.lastname@example.org
To contact the editors responsible for this story: Lynn Thomasson at email@example.com