Wall Street is For Sale - But is it Cheap?

Wall Street is For Sale - But is it Cheap?

New York: During more than a week of stock market sell-offs, investors have been exhorted to use declines to pick up bargains - and with a 7.7 per cent drop on the S&P 500 since August 17, stocks have certainly gotten less expensive.

To determine how cheap they are, investment pros look at yields, earnings and more. By several of those metrics, the bottom line is this: US stocks are not wildly expensive, but they are not the screaming bargains that might pull value-minded investors back into the market.

"We are not getting to a point where it's attractive, it's just not as expensive," said Michael O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut.

That is because investors are willing to pay more for companies that are expecting strong earnings growth. But with Chinese demand weakening, oil prices slipping and the dollar remaining strong even after slipping a bit in the last few days, analyst expectations now are that S&P 500 earnings will fall 3.3 percent from a year ago in the third quarter, according to Thomson Reuters data.

And that makes even less-expensive stocks still pricey.

Here are a few ways to look at stock prices now.

Earnings - Even after Wednesday's buying spree, the S&P 500 stock index was selling at roughly 15.8 times its expected earnings for the next 12 months. That is lower than this year's peak of 17.8 but not far from the average of about 16 since January 2000, and well above the 10.5 percent hit during the last market correction in August 2011.

"Low interest rates have juiced equity valuations to levels more consistent with a rapidly growing global economy than one still stuck in first gear," Nicholas Colas, chief market strategist at Convergex in New York, wrote in an overnight note to clients.

On a 14-times earnings scenario, a multiple more in line with slow earnings growth, the S&P 500 should be closer to 1,700 - more than 10 per cent lower than Wednesday's close - a level that would drag the index into a bear market.

Dividend yields - For some, the argument that there is no other asset besides stocks to invest in due to rock bottom yields in US government debt continues to hold. The S&P 500's dividend yield of 2.57 per cent recently ticked above the 10-year yield according to data from Thomson Reuters Datastream and Fathom Consulting.

This was the case on and off since the start of 2015 until April, and the norm between late 2011 and mid 2013 - a period of strong gains for the stock index. But it has only happened one other time in the last 20 years, between December 2008 and April 2009.

Earnings yield - At above 6 per cent, the earnings yield on the S&P 500 compares favorably with the 10-year Treasury note yield, now just under 2.2 per cent. Analysts say that when the earnings yield is more than twice the yield of the Treasury benchmark it historically augurs gains for stocks.

© Thomson Reuters 2015