At 1,000, Is the S&P Worth Buying?

On July 20, with the S&P 500 at 940, Goldman Sachs (NYSE: GS  ) strategist David Kostin lifted his end-of-year forecast for the index from 940 to 1,060. It took just two weeks -- presto! -- for the market to get halfway there by breaking 1,000!

Here are some "winners" and "losers" from a sizzling July:

Winning Stocks

July Monthly Return

Adjusted P/E Ratio (based on average
earnings over prior 10 years)*

Capital One Financial
(NYSE: COF  )

40.3%

6.6

Intuitive Surgical
(NYSE: ISRG  )

38.9%

56.5

Ford Motor
(NYSE: F  )

31.8%

N/A**

Losing Stocks

 

 

Yahoo!
(Nasdaq: YHOO  )

(8.6%)

32.4

CME Group
(Nasdaq: CME  )

(10.4%)

20.5

Sprint Nextel
(NYSE: S  )

(16.8%)

29.9

Source: Author's calculations based on data from Capital IQ, a division of Standard & Poor's.*Note that the company P/E ratios are not directly comparable to the adjusted P/E ratio for the S&P 500 cited in the text, as the average earnings of the latter has been adjusted for inflation.
**Negative earnings over the last 10 years!

Can it go higher?
Can the market remain on its meteoric trajectory? Of course! There is approximately $3.5 trillion currently parked in money market funds earning less than 1% -- if investors decide they must get in on this rally and re-deploy their cash into stocks, it could certainly push the S&P to 1,060 or beyond. However, no one knows what the market will do in the short term. The more pertinent question is whether it is sensible to pay current prices to own stocks.

Yes, but …
At Friday’s close of 987.48, the S&P 500 is valued at 17.1 times its average inflation-adjusted earnings over the past 10 years -- a premium to the multiple's long-term average of 16.3. Factor in a long, tepid economic recovery, and any premium suggests stocks are now overvalued. As value guru Jeremy Grantham laments in his July investor letter: "After 20 years of more or less permanent overpricing of the S&P, we get five months of underpricing. There is no justice in life!"

3 choices for investors
In that context, investors who wish to increase their exposure to U.S. stocks will be best served by (1) being patient and waiting for better prices, or (2) selecting individual stocks with a careful eye on price. Failing that, there is a wide world outside the U.S. -- international markets, on the whole, look more attractive than the U.S. right now. 

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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Intuitive Surgical is a Motley Fool Rule Breakers recommendation. Sprint Nextel is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (56)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 03, 2009, at 7:44 PM, plange01 wrote:

    there are plenty of great stocks that have not moved and in time its 100% sure they will .2 of my favorites are ba and ge both of these will triple in 3 years or less...this has been a real estate and credit based collapse that dragged everything with it...

  • Report this Comment On August 03, 2009, at 7:49 PM, pondedaniel wrote:

    yep, we cannot forget about the emerging markets across the globe, especially the brazilian one which was deeply damaged since the very beggining of this current crisis. Considering the foreign capital which extraordinarily has been allocated into the brazilian stock market and its remarkable influence we should definitely pore over it.

  • Report this Comment On August 03, 2009, at 8:27 PM, TMFAleph1 wrote:

    plange01,

    Thanks for your interest.

    On what basis do you assert that Bank of America (NYSE: BAC) and General Electric (NYSE: GE) are two stocks that "have not moved"?

    From the March 9 market low, those stocks have gained 309% and 85%, respectively. Even on a quarter-to-date basis (that is, from June 30), the stocks have gained 16% and 17%, respectively. In each case, that is significantly more than the S&P 500, which gained 48% since March 9 and 9% since June 30.

    The truth is that both of these stocks have been extremely volatile. That doesn't mean that one or both of these stocks can't produce good returns over the next three years, but if they do, it won't be because they "haven't moved" recently.

    Cheers,

    Alex Dumortier

  • Report this Comment On August 04, 2009, at 2:38 AM, thisislabor wrote:

    However, no one knows what the market will do in the short term. The more pertinent question is whether it is sensible to pay current prices to own stocks.

    I like this sentence to summarize things.

  • Report this Comment On August 04, 2009, at 10:39 AM, HeronFeather wrote:

    'scuse me, Alex, but plange01 mentioned BA - Boeing, not BAC, Bank of America. Care to comment on Boeing?

  • Report this Comment On August 05, 2009, at 6:52 PM, TMFAleph1 wrote:

    HeronFeather -- Well spotted, thanks.

    plange01 -- My apologies, I misread the ticker and thought you were referring to Bank of America, rather than Boeing.

    As of today's closing price, Boeing shares (NYSE: BA) are valued at just under ten times (9.9x) the company's average earnings-per-share earnings over the prior ten years. On that basis, they rather look undervalued to me.

    Alex Dumortier

  • Report this Comment On August 07, 2009, at 2:21 PM, texastar1 wrote:

    I believe that we will see a retraction of the S&P next week of about 30 to 40 points and then a steady climb to around 1100 by year-end. Trading in between will be fairly choppy, but steady as she goes for the long term investor!

  • Report this Comment On August 09, 2009, at 7:01 AM, suddencomfort55 wrote:

    Hi guys, I have recently bought shares in BEXP and have gained 77% on my money. But I am now wondering what to do sell or hold. Can anyone give me some advice on this please.

    Also does anyone have any advice on UGX?

    Ronnie

  • Report this Comment On August 09, 2009, at 5:13 PM, frozenfour wrote:

    US stocks are overvalued, but internationals are undervalued. Oh, and hey, BTW I work for a stock advisory company that recommends international stocks. Wanna join?

    You just lost any credibility w/me.

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