Plotlines: Bear market bounce for stocks?

May 1, 2008

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The S&P 500 snapped a five-month losing streak in April with its best showing in more than four years, gaining 4.75 percent on the month. Some see that as a sign of a turnaround for stocks, which appear to be near their cheapest in over a dozen years.

A closer look at stock valuations, though, indicates U.S. equities might not be such bargains.

Sure, the price-to-earnings ratio for the S&P remains around 14 times forward earnings estimates, near its lowest level since 1995. On the surface, it suggests stocks are a deal at current prices.

Here’s the hitch: the S&P’s P/E rose 5.14 percent last month, the biggest monthly jump in valuations in more than five years, yet at an 8 percent faster pace than the rise in the index. Stocks got pricier faster than stock prices rose. That’s because the “E” in the P/E — forecast company earnings — continues to slide as analysts factor in such headwinds as the credit crisis and probable recession. That’s rarely a good omen for equity fundamentals.

In fact, over the past two months, stocks have grown 6.8 percent pricier, while stock prices are up just 4.1 percent. The last time valuations grew so quickly relative to prices was in late 2001, when the S&P staged what turned out to be a 3-month bear-market rally. By January 2002, stocks were back on their way down and would tumble another 33 percent before hitting bottom 10 months later.

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As it turns out, the impressive looking 20% losses on this chart are nothing compared to the current outlook. The change for many banks has been starkly more of a decline, with citigroup going our of business today.