There was a fascinating thread on TMF a couple of weeks back with many strongly argued opinions on the valuation of the US market. As I was reading them I thought it funny that I agreed with both, while the participants seemed at complete odds with one another. To me it all depends on what time scale you focus on. Having one view means you are solely focused on one time scale. Perhaps that is fine if it’s a short term view and you keep updating your short term view or if it is a long term view and you invest according to that view and short term under-performance be damned. Though being continuously right about the short term seems like a tough task to me.

In the short run markets can go higher fueled by a high octane mix of government spending and peak margins from unsustainable cost cutting. The US market could provide good returns over the next year or slightly longer. In the long run margins will compress earnings will fall the government stop spending and increase taxes and the US market will fail to provide good long term returns from this point. (Good returns relative to money market accounts.)

I just went to Running of the Bulls to find an old post on average returns after the NonFarm payrolls turned positive and instead found the following valuation update. Confirmation bias alert. Toro makes my point very succinctly in a few short sentences and summarises with, “Margins matter more in the long-run than the short-run, though. Thus, over the near-term, valuation is not worrisome.” Read his post for the details.

Here is Toro’s post I was looking for. NonFarm Payrolls Suggest Higher Market

Generally, the market moves higher when nonfarm payrolls turn positive.  At the end of the previous six recessions, the average gain of the S&P 500 a year after NFPs turned positive for good has been +5.7%.  In only one instance was the market negative a year later, which was in 1981.  Not coincidentally, nonfarm payrolls turned negative in September 1981 as the economy plunged back into recession. The highest one-year return was +9.5% in 1976.

This pales in comparison to buying the market at the depth of the recession.  At the nadir of job losses, when job losses are at their worst, on average the market was 43% higher a year later.

Contemporary history suggests that the market is headed higher from here, though most of the returns have most likely occurred.  The question is whether or not this time period is contemporary?

Finally from Toro, a good range of models for valuing the US market. As Toro points outs models should be used for an approximation not precision and in the short term valuation means diddly squat.

Another view from David Rosenberg, Chief Economist & Strategist at Gluskin Sheff. Rosenberg has had a bearish bias since his first article at Gluskin Sheff back in May 2009. He was calling the market expensive then with the S&P500 around 900. He is sure to remain bearish and at some point he’ll be right! In this case here’s another log of confirmation bias for my fire.

FORGET THE ANALYST ESTIMATES
Bloomberg News runs with this — U.S. Stocks Cheapest Since 1990 on Analyst Estimates. The article goes on to say that based on the $86 EPS estimate being penned in by the consensus for 2011, this is one cheap stock market. The elite would seem to concur with this notion that with the recession’s ink barely dry and the credit contraction lingering, we are heading back to cyclical peak earnings.

But here’s the rub. Going back over the past 25 years, the consensus has been overly optimistic on earnings 75% of the time and they have missed on a 12-month horizon an average of almost 20%. So the answer is no — the market is more likely trading closer to a 16x P/E than the sub-13x multiple being bandied about by the always rose coloured bulls. On a Shiller trailing P/E basis, the market is trading at 22x. That ain’t no bargain, being six multiple points above the long-run norm.

We are sure to get our share of naysayers emailing us back. Our response, to those who need to be versed in the historical record: Benjamin Graham never
ever deployed ‘forward’ earnings as a valuation metric.
via Breakfast with Dave

Disclosure: I predominately continue to sell fairly and overvalued companies into this rally. My cash position is still increasing.

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4. Hussman Funds Weekly Market Comment
5. Australian Share Market Returns and Equity Premiums
6. Australian Share Market Performance and Returns