Adam Sarhan Quoted in MarketWatch: Goldman’s CAPE fear — and what it means for this stock run

March 12, 2013, 3:57 PM

So Jim O’Neill of Goldman Sachs is concerned about the so-called CAPE ratio, which he said is indicating that stocks look expensive.

Bloomberg News/Landov
Jim O’Neill at 2011 forum in Hong Kong.

CAPE refers to the cyclically adjusted price-earnings ratio that helps smooth out economic cycles as it looks at earnings by dividing the S&P 500 price by the average of 10 years’ worth of historical real earnings.

Goldman Sachs

So how much do investors have to fear this CAPE ratio? Adam Sarhan, chief executive officer of Sarhan Capital, disagrees with the conclusion based on this single metric that stocks are expensive. “I do not disagree with the CAPE perspective or number. I just think there are other more important pieces to the puzzle that determines stock prices.”

“There are many ways to value stocks — the most common is a basic P/E, and the P/E for the S&P 500 SPX +0.15% right now is near its historic norms. Furthermore, the Fed is printing billions every day, and that is the key factor driving stocks higher.  The Fed’s intention is to stimulate the economy. … If the economy gets going [with GDP growth of over 2%], then one should expect sales and earnings to grow, which should help. Many sectors also sport attractive valuations.”

Here’s what Stephen Pope, managing partner at Spotlight Ideas, has to say about the CAPE metric:

“The current CAPE ratio is around 23 times earnings, while the long-term CAPE average is approximately 16 times. So the argument goes that equities are currently significantly overpriced by historical standards.

“My view is that of course, the CAPE ratio is useful when combined with other valuation techniques to determine the relative attractiveness of  equities [but] it is a ratio with serious limitations as  a stand-alone value metric. … Who  in 2013 is ever going to invest in a stock because of what it earned a decade ago? The answer is no one”

Steen Jakobsen, chief economist at Saxo Bank, agrees with Goldman in that valuations have become “separated from reality.” His concern surrounds a different metric:

“Momentum drives the market now, and we are concerned at the high level of insider selling into this.”

He cites a March 1 article from Zerohedge, in which TrimTab’s CEO Charles Biderman says  while retail investors are being told to buy buy buy, “insiders at U.S. companies have bought the least amount of shares in any one month.”  The ratio of insider selling to buying is now 50-to-1 – a monthly record,” says Biderman.

“We’re big CAPE proponents here, believing its quite useful for medium to longer term investors,” reports Dan Greenhaus, chief global strategist at BTIG LLC in New York:

 ”And the CAPE is quite clear [that] equities are unequivocally not attractive based on this longer-term measure.  However, the CAPE’s biggest drawback is that it’s not a market-timing tool, and, while this measure suggests forward returns will be modest, it doesn’t preclude exceptional one or two-year forward returns.”

On a day that U.S. stocks have largely been in pause mode,it  might be worth taking a look at what a recent MarketWatch survey of bears/bulls had to say.

– Barbara Kollmeyer

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