Why PE ratios are useless in finding a market bottom

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

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. dumps with pin shop commented on Jan 26

    … [Trackback]

    […] Information on that Topic: thereformedbroker.com/2020/03/19/why-pe-ratios-are-useless-in-finding-a-market-bottom/ […]