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Why PE ratios are useless in finding a market bottom

 

Why PE ratios are useless in finding a market bottom

Courtesy of 

My friend Savita Subramanian (BofA Merrill Lynch) says there are six things that usually occur at major bear market bottoms, and all six of them are there already or almost there. These range from earnings revisions to Fed moves to the financial stress indicator.

One interesting point she makes is that there is a very wide range of PE ratios at or near stock market bottoms. The range is so wide, in fact, that using this measure is basically pointless.

PEs are pretty useless: wide range At prior bear market troughs, trailing Price to Earnings (PE) multiples have ranged from 11x to 18x (today’s is 15x) and forward (NTM consensus) PE multiples have ranged from 10x to 15x (today’s is 16x). But historically, the market has troughed at an average PE multiple of 13x to 14x actual trough earnings, a posteriori. Applying this to our recently introduced 2020 recession EPS forecast of $138 yields a floor (worst case scenario) on the S&P 500 of 1800. But note that this is a much lower outcome than applying the typical peak-to-trough bear market decline of ~35% to February’s S&P 500 peak of 3393, which would yield a floor of 2200 (still below today’s levels). Our year-end 2020 target for the S&P 500 remains 3100.

Savita notes that if we go by the typical bear market decline of 35% peak to trough, then 2200 makes sense. If we go by Merrill’s new S&P 500 recession earnings forecast, and apply a PE at the midpoint of the above mentioned range, we’re talking more like 1800. SPX is about 2400 as of this posting.

Source:

Finding an S&P Bottom
Bank of America Merrill Lynch – March 19th, 2020


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