Commentary: Paul Ebeling on Wall Street


Y 2020 extended Y 2019 action as the big tech names led and the smaller-caps lagged.

While the S&P 500’s valuation chart may be giving some investors flashbacks to the Y 2018 market meltdown, the Bulls are resolute.

Corporate earnings are expected to fall for a 2nd Q running, as the reporting season begins in earnest this week.

Meanwhile, share prices keep rising, with the benchmark gauge notching fresh records in the early days of Y 2020.

The disconnect is unsettling to some. As it has driven the S&P 500’s P/E multiple above the levels reached in early Y 2018, which preceded a correction of more than 10% in a matter of weeks.

While the valuation chart may look off putting, some strategists have come out with explanations about why this time is different. They point to the Fed. In Y 2018, the Fed was in a campaign of raising interest rates. Last year, they cut them 3X.

“Investors are becoming comfortable with the notion that equities valuations can re-rate higher in an environment of benign inflation, accommodative Fed, stable to improving growth outlook, along with significant cash on the sidelines,” said the co-Founder of Fundstrat Global Advisors LLC.

Further expansions are likely, and each 1-pt increase in the P/E ratio is equivalent to a 5% gainer for the S&P 500.

Valuations have surfaced as a hot issue after the S&P 500 rallied almost 30% last year, with almost all the gains underpinned by multiple expansions. At current marks, stocks are trading at the richest valuations since the the Clinton administration burst the Internet bubble.

The multiple-driven rally has had Goldman Sachs Group Inc. fielding client calls about parallels between now and the turn of the Century. The firm’s strategists suggested it is too early to worry, pointing out that the S&P 500’s current forward P/E ratio of 19 is well below the multiple of 23 at the start of Y 1999.

Stocks also are more attractively valued relative to fixed income the team argue. The S&P 500’s earnings yield, a measure that is inverse of the P/E ratio, now stands about 340 bpts above the 10-yr Treasury yield. By contrast, stocks offered a yield that’s 26 bpts below Treasuries 21 yrs ago.

At Bank of America, strategists see the potential for stocks to keep rising until the index’s forward P/E ratio hits 20. For early signs of market trouble, watch high-yield bonds, chipmakers, homebuilders and financial shares, as the underperformance of these groups served as prelude to a Top in Y 2018, they say.

At some mark, the elevation in multiples is the market’s way of predicting better earnings ahead. Such optimism does not always occur, as was the case in the late 1990’s.

In Y 2018 earnings surged, partly helped by President Trump’s tax cuts. S&P 500 profits ended the year about 10% higher than what analysts expected in January, according to data compiled.

This time, while growth is stagnating, analysts see a rebound coming.

Profit expansion will accelerate to 9% this year from 1.5% last year and exceed 10% in Y 2021, estimates show. With the S&P 500 hanging at 3,265, stocks look expensive trading at 20.3X Y 2019 earnings. But based on profits for the next 2 years, they look less stretched at a multiple of 18.6X and 16.8X, respectively.

The market is relying on the upcoming earnings season to deliver a positive tone, which seems more likely to come from revisions to guidance than recent revenues and profits.

Some dismiss this as ‘hope’ rather than ‘reality,’ it does seem likely that a good deal of corporate investment was put on hold between mid‐Ys 2018 and late 2019 and that a turn in corporate sentiment might actually have some measurable real world effect.

Heffx-LTN’s overall technical analysis for the US major stock market indexes is Bullish to Very Bullish going into this week.

Have a terrific week

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