Despite its dip over the past two months, the stock market still has logged a good performance this year, with the S&P 500 up 12.2% as of Friday. Still, this run, a heartening bounce back from 2022’s carnage, has left equities expensive: Using reported earnings, the index’s trailing price/earnings ratio is up to 23.2, ahead of its long-term average by about seven percentage points.
Those lofty valuations are an impediment for stock buyers. But stocks will not maintain that high altitude for long, according to David Rosenberg, an influential economist, who previously served as the top North American economist for Merrill Lynch (now part of Bank of America). Reason: The U.S. economy is shakier than it may appear.
In a research note, Rosenberg wrote that “these high P/E multiples look unsustainable in the face of a high-for-longer Fed and a ridiculous 100 basis point equity risk premium.”
Now the head of his own shop, Rosenberg Research and Associates Inc., Rosenberg argued it is absurd for investors to “take on the risk at these relative valuation levels” when there is a lot of evidence that today’s high P/E levels are sure to decline, along with the market.
Indeed, the Federal Reserve signaled, in its September meeting, that it intends tomaintain current interest rate levels for a while, dashing the hopes of bulls who expected the Fed to ease somewhat. The central bank’s campaign, underway since early last year, to hike the benchmark rate to more than 5% from near zero, appears unlikely to flag. Last Friday’s strong jobs report buttressed the case for a sustained level of relatively high rates for now, Rosenberg stated.
The equity risk premium (the difference between the index’s earnings yield and the 10-year Treasury yield) now stands at a mere 0.7 percentage point. Over the past dozen years, the average has been more than 5 points.
Rosenberg pointed to evidence that the U.S. economy may be starting to crack: The Conference Board’s leading economic indicators have fallen for 17 consecutive months, the Institute for Supply Management’s purchasing managers’ index is in contraction mode (namely below 50—it was at 49 in September) and credit card delinquency rates are rising. Add in slowing growth for U.S. gross domestic product and similar woes in Europe, Japan and China, and the picture is not bright for continued stock increases, Rosenberg opined.
Meanwhile, he accused the Fed of having “a complacent view on the U.S. economic outlook” as it winds down its huge inventory of bonds. All of this is going to “catch a whole lot of macro bulls by surprise,” he noted.
Related Stories:
What Worries CIOs Most? Inflation and Valuations
‘No Landing’ Economy? Can’t Happen, Says LPL Savant
Hard-Charging Tech Stocks May Slow for the Rest of 2023, Ned Davis Says
Tags: 10-year Treasury yield, Conference Board, David Rosenberg, earnings yield, Economy, equity risk premium, Federal Reserve, P/E ratio, valuations