This is a technical strategy site that incorporates sentiment and timing elements; one area of my total market view I have not discussed is valuation.
First, Wall Street runs on valuation so there are people who know far more than me. Second, I don't have the tools I like to use (aka Bloomberg) so have not really addressed it in these posts.
But while working for a hedge fund for 3 years I cobbled together a valuation monitor for the S&P. It was not fancy but I think complexity can be over-rated; like my sentiment watch the important thing is relative valuation and the combination of certain levels and price response.
For example, Tony Caldaro of The Elliott Wave Lives On recently summarized in a study what I knew to be the case: valuations are all over the map. He cites: "bull market multiples have been as low as 9 in 1980, as high as 35 in 2000.... bear market multiples as low as 6 in 1949, as high as 23 in 2002." And 1929 surprisingly topped out at 20!
So with this history how does one take an official stance that any p/e is under-valued or over-valued? I'm sure there is all kinds of financial complexity to address this question, but as stated above I prefer a simpler method. Here's an example.
The Wall Street Journal lists the current (trailing 12 month) p/e for 3 Dow indexes, the Russell 2000, the Nasdaq 100 and the S&P 500 here.
The current numbers are n/a for Russell (negative p/e which is why that has led on the drop), 21 for NDX and 23 for SPX! That sounds high but the more important number is the estimate. These are provided from Birinyi Associates and maybe different than Bloomberg. Keeping to the S&P, the current 12 month forward p/e is more in line at 16.72 with SPX closing on Friday at 2022.
Simple division tells us the current SPX earnings estimate is 120.93. That may continue to change, and both the changes and rate of change are something to watch, but let's plug in some other p/e ratios.
15x = 1814
16x = 1934
17x = 2055
18x = 2176
19x = 2297
The recent February low was 1810 - and I don't think this was a coincidence! In the current environment, Wall Street saw 15x forward earnings as under-valued and buyers stepped in. Surely there was not a huge change in estimates in just 4 weeks. In fact if the estimate was a bit lower like 120.70, then the 1810 low was precisely at 15x forward earnings.
There are enough turns on the big round numbers to watch this sort of thing. Last year a lot of the May to July highs were near 18x forward earnings. Big players like David Tepper were selling there at that valuation. That article has a typo (high 2034 not 2014) but this coincided with 18x earnings at the time. Trust me, I was watching this daily at the time, and there were just too many readings with S&P p/e at 17.97, 17.98, 18.01 etc right at the highs for this to be random.
Based on the recent low of year very near 15x earnings it may be the estimates from Birinyi are about the same as the Bloomberg. Where will sellers come in? If we see 18 again that means a lot of upside. In the context of FOMC rising rates and election uncertainty (surely Wall St at this point prefers H over DT) we may not see 18x, in which case 17x 2050. I will remain bullish above long term pivots on the Dow, SPX, NDX etc but at the same time we may have conditions for a fade, with a lot depending on oil and FOMC. But if we see 18x earnings again, then that will roughly align with the SPX YR1 at 2163!
The ideal setup then becomes: long term pivot level hold or change of status, ideally with VIX confirming, and even better with other technicals in favor like RSI divergence if picking off a low and maybe some other moving average in support; with a sentiment extreme, especially on lows; ideally in a timing window, like we had on 2/11-15; and a valuation level / round number.
All these did come together on 2/11-15, although I was not aware of the valuation at the time and I thought maybe the sentiment extreme was not quite enough. Although I mis-judged the last Model A idea, 2/11-15 timing turn (both model A & B) was bang on.
So I'll be keeping all this in mind for the next turn.