This article is a guest contribution by David Rosenberg, Chief Market Economist, Gluskin Sheff, Toronto.
Intel enjoyed its best quarter ever at the peak of the inventory cycle. Well done.
What we are grappling with is this. If the consensus earnings forecast is âthe marketâ, then the S&P 500 is de facto pricing in $96 of operating earnings next year â a new peak. Now that is a 35% increase from here and it is extremely difficult to see profits soaring that much at a time when margins are already back at cycle highs and with the prospect of slowing nominal GDP growth. It just does not add up.
Well, one can always say that even if earnings come in at $80 in 2011, whatâs the guff? Slap on a 15x multiple and you still get to 1,200 on the S&P 500.
Of course that 15x is what the bulls use because periods of âlow inflationâ deserve a higher multiple. Well, that may have been true in periods of supply-driven disinflation (deregulation, freer global trade, labour mobility, tech-driven productivity growth, and lower marginal tax rates) but what we have today is a disinflation soon-to-become deflationary trend induced by a credit contraction deficiency in aggregate demand. There is a qualitative difference.
Looking back over the past 60 years, the range on the trailing P/E multiple in low inflation (sub-2%) periods was 6x to 30x. You can drive a Mack truck through that. Keep in mind that the average and median P/E in low inflation periods were skewed up by the secular credit expansion that began in the 1960s and morphed into a mania by the 80s and then into a bubble through much of the 90s through to the parabola of the last decade.
We are on the other side of the debt-to-GDP chart. We are going back to a much more stable and less leveraged environment â back to that period in the 1950s low inflation era that was stable and not driven by debt growth, and the P/E back then averaged 11x. So, slap $80 of earnings on that and you ultimately get the market to a level that we may be able to build capital appreciation strategies around. Getting there wonât be pretty, especially from current levels, but once we do, remember â the 1950s was a pretty darn good investing environment.
In the interim, patience will be virtuous. Stay disciplined. Focus on yield, coupon clipping and capital gains in bonds while you wait.
