S&P 500 Index PEG Suggests Overvaluation

The S&P 500 index is trading at record high levels and optimism remains high with Barron's professional money manager survey indicating a record 74% money managers being bullish on markets even at current levels. 

The PE ratio is one good measure of market valuation. The PEG ratio makes this measure complete as it takes future growth into consideration and measures valuations with respect to expected growth. For the S&P, the PEG ratio suggests overvaluation at current market levels. The chart below gives the PEG ratio for the S&P 500 index along with the PEG for the mid-cap and small-cap stocks. In general, a PEG ratio of over 1 indicates overvalued stocks or markets. Certainly, valuations are stretched at current levels. 

US market PE and PEG Valuation

It is also important to note that the PEG ratio has been calculated based on FY13 expected earnings of $107.55. I am of the opinion that earnings estimates might be just too optimistic. The actual earnings for FY12 was $86.5. It might be unrealistic to expect a 24% earnings growth in the current economic scenario. Therefore, if FY13 earnings estimates are revised downwards, the PEG ratio will indicate even more expensive markets. 

The conclusion is to avoid fresh exposure to equities at these levels. Investors can consider booking profits and considering fresh exposure on corrections. I do expect equity markets to witness a meaningful correction over the next 3-6 months.

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The S&P 500 Earnings Growth Momentum Waning

The S&P 500 is trading at near record high levels on the back of liquidity glut in the financial system. I mention the liquidity factor because all other fundamental factors do not support current levels and valuations.

The charts below give the S&P 500 operating earnings and as reported earnings growth (calculated on a TTM basis). 

Growth in Standard and Poor's 500 As Reported EPS

Growth in Standard and Poor's 500 Operating EPS

Very clearly, the earnings growth momentum is on a rather sharp decline. This is understandable considering the following facts - 

1) Euro zone is in a recession and the IMF project negative growth for the Euro zone in 2013
2) China has witnessed a meaningful slowdown and growth momentum is unlikely to pick up soon
3) India is also witnessing a slowdown and government policy paralysis will continue to hinder growth
4) The US might also be heading for a slowdown with negative growth in March 2013 retail numbers

All these factors combine to suggest weak global economic activity. Also, growth momentum will not pick up in the foreseeable future. Amidst these concerns, it is surprising to see the S&P 500 trading at near record highs. The most likely conclusion is the liquidity factor as there is no other positivity the equity markets might be discounting.

Considering these factors, I would suggest investors to stay away from the markets for the remainder of 2013 in terms of considering fresh exposure. Investors can also consider lightening their equity portfolio amidst the current slowdown. Any meaningful correction over the next few quarters will give a good buying opportunity.

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People Not In Labor Force Surges To 90 Million

The US headline unemployment rate has declined from a peak of 10% to 7.6% as of March 2013. In general, this can be considered as a positive economic indicator. The devil is however in the details. The number of people not in the labor force has reached a record high of 90 million in March 2013. The number of people not in the labor force has increased by nearly 13 million since the beginning of 2007. This has resulted in a relatively brighter looking headline unemployment rate. The chart below gives the number of people not in the labor force. 

Number of people not in labor force


The civilian labor force participation rate is reflective of the point I am talking about. The rate is at a 3 decade low as indicated by the chart below. 

Labor force participation rate


This effectively means that a smaller number of working population have to support an ever increasing dependents population. This is certainly a cause of concern in an economy driven by consumption. These two data also reflect the ineffectiveness of Fed's policy on the real economy. The headline unemployment number would have been worse had the number of people not in the labor force remained stagnant after 2007. 

In conclusion, the real jobs market and economy is worse than being projected by some key government published data, which is unfortunately used to talk about the prevailing economic trend.

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