Investors chasing a rally ‘on faith’

David Rosenberg is warning that stocks are more expensive than at the pre-financial crisis peak, and that investors buying in at these levels are banking on an earnings stream that is unlikely to materialize for several years.

The forward price-toearnings multiple on the S&P 500 has expanded to 18.5x on a 12-month forward basis, the Gluskin Sheff economist wrote Thursday in Breakfast with Dave, his regular morning note.

Whether looking at the norm for the past decade, or the average of the past 25 years (excluding the dot-com bubble when burgeoning tech companies had no earnings), it’s a sign that the market is pricey, Rosenberg says.

“The market is more expensive now than it was at the 2007 peak when it was a snick below 17x on a forward basis,” he said in the note. “I think this may answer the question as to whether prudence calls for taking profits at this point or chasing what seems to be a rally predicated on faith, hope, repositioning and momentum.”

The stock market is pricing in some 30 per cent earnings growth over the next year, said Rosenberg. That kind of profit growth is a one-in-20 event occurring just five per cent of the time in the past six decades, he said.

A multiple of 18.5x often occurs at or near the top of the bull market cycle, he added.

“Investors buying the market at today’s level are (perhaps unwittingly) paying up for an earnings stream that is unlikely to materialize before 2021 or nearly four years out,” he said. “That is what I call testing anybody’s patience.”

Rosenberg’s warning comes as Canadian corporate profits rose 14 per cent in the third quarter to $80.7 billion according to Statistics Canada, marking the first quarter-over-quarter gain following four consecutive declines.

Year over year, operating profits for Canadian companies were down 1.1. per cent from the third quarter of 2015.

A bump in profits was expected as the impact of the Alberta wild fires died down, said Dina Ignjatovic, an economist at TD Economics.

Profits should continue to rise for the rest of 2016 on a healthy U.S. economy, weak Canadian dollar lifting exports, and higher commodity prices boosting revenues, she added.

“That said, further out, the outlook has been clouded by the outcome of the U.S. election, as pro-growth policies could sustain Canadian demand and profits, but increased protectionism in the U.S. could have the opposite impact,” Ignjatovic said.

In the U.S., the most recent official figures show that corporate profits dropped by 0.6 per cent or US$12.5 billion in the second quarter to US$2.021 trillion (seasonally adjusted at annual rates), according to the U.S. Department of Commerce. This comes after rising US$66 billion in the first quarter.