Stocks May Be Too Cheap Even In These Uncertain Times

This column is my opinion and expresses my views. Those views can change at a moments notice when the market changes. I am not right all the time and I do not expect to be. I disclose all my positions clearly listed on the page, and I do not trade my account on the stocks spoken of in this column unless fully disclosed. If that does not work for you stop reading and close the page. Do not bother me or harass me.

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Volatility once again was the star of the trading week ending March 6. My expectations are for those wild price swings to continue. We had some nice momentum on Tuesday, which lead the index to break what I thought at the time was a critical downtrend, it turned out to be a fakeout, with the index moving lower. That won’t happen again; from now on, we proceed with caution and wait for verification. 

S&P 500 chart

Regardless there does seem to be some meaningful levels of support in the 2,800 to 2,900 region for the S&P 500, and I think there are fundamental reasons for that support. My models show that earnings for 2020 and 2021 are beginning to get pulled down some, but what I find most interesting is that there appears to more significant uncertainty being priced into those estimates. I reviewed this in the webinar for premium member on Thursday night. You can watch the replay by signing up for the premium services by following this link. Webinar Tonight At 9 pm

Currently, my models are estimating earnings growth in 2020 of $169.79, and $190.44 for 2021. That is down from a reading of $170.37 on February 28 and $190.67. It is not a dramatic drop, but the trend is lower at this point. 

ESP Est.2

But more interesting to me is the range for the standard deviation for the earnings estimates. It creates the upper and lower bounds of my earnings estimates, and that is widening. It would indicate to me that there is growing uncertainty in earnings estimates going forward into 2020, and in 2021.

In the next chart, I show that the trend for the spread between the lower and upper range of my earnings estimates have historically been trending lower, but now that spread is rising.

spreads

As I go through the different scenarios from my data, I come up with up varying ranges for the S&P 500 using the best, worst, and base cases for the S&P 500. You can see my PE ‘s for each of these scenarios for the S&P 500 at its current value.

The chart below shows that in a worst-case scenario, I am modeling for earnings $179.50 for the S&P 500 in 2021, giving the S&P a one-year forward earnings multiple of about 16.5, which is below the historical average of 17. In this type of uncertain environment, I could argue that PE should maybe lower, towards 16, which would value the S&P 500 around 2,870.

PE ratios

If we take this one step further, we know that the S&P 500 has a 20 quarter moving average PE ratio of 17.4. That creates a one standard deviation range above and below that average of roughly 16.2 to 18.6. I compiled the next chart using historical data from S&P Dow Jones, and their operating earning metrics.

moving average

Ultimately, I come to the conclusion that in a worst-case scenario using my estimates, which is one standard deviation below my base case earnings estimate, and one standard deviation below the S&P 500 20 QMA PE ratio, the S&P 500 should have a value of 2,899.50. In a perfectly neutral case, the S&P 500 should be worth 3,305.

I took this approach even one step further and assumed no earnings growth in 2020 and a 10% growth rate in 2021. It would give the index earnings in  2021 of $172.85. In that case, in a worst-case scenario where the S&P 500 trades at 16.15 times 2021 earnings estimates, it is worth about 2,792. If we do pass these uncertain times and the multiple expands to the upper end of the PE range towards 18.6, the S&P is worth about 3,206, again assuming no growth in 2020 and 10% growth in 2021.

S&P 500, values

The bottom line, if you are wondering why the S&P 500 has some support in this 2800-2,900 region. It appears that the market may be pricing in a no earnings growth in 2020 scenario. If that’s not the case, then equities likely only have one way to go from here, and that is probably higher.

Hopefully, this wasn’t too confusing to follow.

-Mike

Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.      

 

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