Market nears a good entry point, but more corrections to come

There is a very data rich article speaking about how stocks are at a better valuation than they were 3 months ago. The main argument is that P/E and CAPE metrics for the S&P 500 and lower than three months ago.

Although, this is an excellent observation. It does not even start to speak to the long-term picture. Yes the forward PE today for the S&P 500 is around 12.5, which is lower than the 14's and even 15's we have observed over the past few quarters.

However, let's think about the long-run historic average. This is 12.1 form 1976-2003. Now this number includes a wide array of different economic situation, nonetheless we should be able to equate the average economic expansion over the same time period to that PE.

Now we have to ask, is paying 12.5x the earnings today as valuable as paying 12.1x for stocks for the 27 year period. Remember, we are talking forward P/E so you have to imagine you are always looking into the future for each year/quarter. The fact of the matter is although we had some down cycles between1976-2003, this period is marked by a good majority of rosy looking years, and really only a couple of years that the markets lost double digits or were in a recession.

Now, do we really think over the next 3-12 months the economy is slightly better than the 80's or 90's. I'm not so sure. Overall, business activity is going to continue to struggle. We are facing a double dip in housing prices, Europe debt struggles, Banking profitability issues, soft consumer confidence, and weakening consumer spending.

The fact of the matter is that future earnings and the growth potential are going to be weak over the next few quarters. Thus, they should actually pay less, for a slow growth economy.

The only argument is that investors are facing a greater risk in the market, and therefore require greater returns for their money. However, this is pricing that will lead to a bubble. As investors continue to price stocks at slight higher and higher PEs. Then eventually investors will realize they have overpriced their earnings, leading to a pop of the bubble.

In summary, to say its a better point to enter the stock market than 3 months ago is not entirely true. The economy has had a considerable amount of bad news dealt to it. And, the lower PE is to be expected. Also, the higher than historical average PE mean that the market will likely be mean-regressing (return to historical averages). This will happen in two ways, either the price valuations will lower, or forward earnings will lower. In either event, there is still some downside in the pricing.

Takeaways: we are near a good entry point, be very hesitant, if the stock market begins to drop another 5% it might be a good time to throw a small to medium sized allotment at the market.