For S&P 500, Expensive Is New Cheap as Bull Market Plods OnJoseph Ciolli
Rarely has it cost so much to purchase low-priced stocks.
With oil’s rebound helping U.S. energy producers recover from a 27 percent plunge, the least-expensive industry in the Standard & Poor’s 500 Index just became banks, where the median company trades at 17.6 times earnings from the past 12 months. That’s no bargain: only once has the cheapest sector commanded a higher valuation, a quarter century of data compiled by Bloomberg and Leuthold Group show.
The lack of bargains is another challenge facing investors after a six-year rally added $17 trillion to equity prices. Alternatives to stocks are already scarce with bond yields hovering near record lows. Now, pickings are getting slimmer in equities just as profit growth has ground to a halt and the Federal Reserve is preparing to raise interest rates.
“Investors are being dragged kicking and screaming into the stock market because, while valuations are not cheap, there really aren’t any better options,” Tom Mangan, who helps oversee about $6.4 billion as a money manager at James Investment Research in Xenia, Ohio, said by phone. “Investors will have to identify undervalued stocks individually, not by sector.”
While elevated, the U.S. stock market’s overall valuation isn’t far from its historical average. The S&P 500’s price-earnings ratio is 18.8, about 2.4 points above the 10-year mean and 38 percent below its 1999 record.
The S&P 500 slipped 1 percent at 4 p.m. in New York.
Below the surface is a valuation pattern traceable to the bull market’s breadth. Since so few companies have been left behind since 2009, almost nothing is cheap.
“You’re seeing commonality in stocks right now, particularly those in the lowest-valuation sectors,” said David Kahn, managing director at Convergent Wealth Advisors in Los Angeles. The firm oversees about $8.4 billion. “They, in particular, tend to benefit less from a low interest rate.”
While banks became cheapest in March, they’ve recently come back into favor with investors anticipating an interest rate increase by the Federal Reserve. Financial firms have risen in four of the last five weeks.
A recovery in crude oil prices after a 60 percent plunge has underpinned a recovery in energy stocks, which have gained 7.1 percent over the past 10 weeks.
To money managers like Gene Peroni of Advisors Asset Management Inc., the confluence of S&P 500 valuations is an opportunity. Rather than an impediment that thwarts stock picking, it’s a sign that growth pervades the economy.
“Higher P/E stocks don’t frighten me, necessarily, given what stage we’re at in the market cycle,” Peroni, a fund manager at Advisors Asset Management in Conshohocken, Pennsylvania, said by phone. His firm oversees $14.7 billion. “This tends to be the most exciting and rewarding stage of the market anyway.”
The Russell 1000 Growth Index, made up of companies with the highest price-to-book ratios and forecast earnings growth, is trading close to its highest level in 14 years relative to its value-focused counterpart. The growth gauge rose to 0.99 times the Russell 1000 Value Index on April 27, the highest since 2001.
At the same time, profit growth shows signs of slowing after a five-year expansion. Overall S&P 500 earnings will fall 6.4 percent in the second quarter and 2.6 percent in the third, according to analyst estimates compiled by Bloomberg.
Indicators of breadth show where all the bargains went in the U.S. bull market that began in March 2009. An average of 379 companies in the benchmark index have increased during each of the six years from 2009 to 2014, compared with 307 in the 1990s, data compiled by Bloomberg show.
Another way of gauging it is to compare the S&P 500, a market capitalization-weighted index whose biggest constituents exert the most influence, to the S&P 500 Equal Weight gauge, where such biases are stripped out. Larger gains in the equal-weight measure are a sign that gains are spread out among members.
Right now, the equal-weight gauge sits at 1.58 times the price of the S&P 500. On April 6, the measure rose to 1.6 times, the highest since data began in 1990.
Too much enthusiasm is what will bring the bull market down, according to Doug Ramsey, who helps oversee $1.6 billion at money manager Leuthold Group in Minneapolis. Warning signs include surveys showing high levels of confidence among consumer and bullishness among market watchers, as well as the popularity of passive equity strategies, he wrote in a May 7 client note.
Ramsey, an early bull who has cut stock holdings from Leuthold’s tactical fund in the last year, says earnings that fueled the bull market are stalling too soon. The S&P 500 will be seeing profit contraction 12 months from now, he said in a May 5 interview on Bloomberg Radio with Tom Keene and Michael McKee.
“You’re not going to have a margin acceleration at this point in the economic cycle,” Ramsey, Leuthold’s chief investment officer, said by phone. “It’s a broadly overvalued market.”
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