Is stock markets really recovering or another bubble? A P/E PEG case study of SP500
COVID-19 is just like a needle which piereced the bubbles of US stocks markets. We all know that US stocks are over-priced, but we are so used to it and hence kind of ignoring it. Lets take a closer look at some of the interesting details about SP500.
The crash and PMI.
SP500 started to collapse in late February when investors realized that the impact of COVID and related government restrictions are "real". At that time, some of the companies were claiming that the Q2 forecast will be just fine as the demand will go up (basically). However, I can tell you these companies are LYING. Simply take a look at the US PMI. For those who have no idea about PMI, PMI is simply the confidence of the expectation from the demand/purchasing side.
Whenever PMI is lower than 50, that means the purchasing managers are not considering buying. The above graph from Trading Economics forecasts that the PMI index will not recover to 50 level until Q4 2020, and Q2 2020 will be a real disaster at lower than 40. So, for these companies forecasting sales growth and revenue growth for Q2 2020, where the hell is that growth coming from?
Recovering or creating another bubble? P/E, PEG approach
Below is a screenshot from Google of SP500 index. The index started to recover on the 23th of Mar and closed at 2929.8 8th of May. No matter if you believe in technical analysis or not, based on the shape of the chart, the SP500 index would probably “recover” further from the crisis.
Source: Google Stock Search
However, we have to be able to see through these price changes and dig deeper. Two basic concepts here: P/E multiples and PEG ratio. P/E multiples is how much you are investing in companies “productivity” (I would not rather say Profits) and P/E multiples implies how long you can break even. I.e. if you invest 5 dollars to a 1 dollar productivity, you need 5 years to break even (simplicity). PEG makes the P/E concept more dynamic, given your expectation of g, the breakeven point can be sooners.
Example: Assume trailing P/E
Stock A: P/E= 20 g=0.1 (10% growth) then PEG=20/10=2 (base case)
Stock B:P/E=20 g=0.5 (50% growth) then PEG=20/50=0.4 (best case)
Stock C: P/E=20 g=0 then PEG=20/…..?????? (WTF)
So now you have a sense about what is going on with the market. Lets recap again,
PMI indicates demand side collapse, excess supply will lead to supply clearing.
Low PMI leads to negative or low growth rate, g.
PEG ratio of SP500 companies will goooooooooo up.
The productivity or earnings of the companies are overpriced. (even though the nominal prices are lower)
Finally, check this research out it is from Yardeni.com. Be careful about industrials, consumer staples. Are you still considering them recovering?
Finance Mojo. from MBA Finance Club