I came across the chart below - it’s not my work & I cant find accredition - and it’s one of the cleaner analog/fractals I’ve seen in a long time.
So the question is, will the pattern hold? Will we continue matching the long sideways pattern we saw in the late 40’s?
The recent draw down has brought the market to fair value at 16.2X fwd EPS. There are 2 caveats to note:
Earning are the foundation of the market, and price tends to follow earnings…although at inflection points it often leads earnings.
A fair value at 16X fwd EPS assumes that earnings will grow at 10% / year.
For the market to command a higher P/E multiple, we will need earnings to grow more than 10% or the cost of capital to decline. Neither of these scenario’s seem likely and are less likely to take place simultaneously.
If the former happens, it suggests that the economy remains hot and that the Fed will have to push the cost of capital higher…it’s hard to see higher multiples in a rising rate environment.
If the latter happens, it suggests a weakening economy that puts 10% earnings growth at risk…that could be a catalyst for another leg down.
So, despite the move from 23X to 16X fwd EPS, the market is fairly priced and certainly not a bargain. Damned if we do, damned if we dont - perhaps sideways is the new up!