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September 5, 2020
STOCKS – None
Macro – SPY
Mike’s Reading The Markets (RTM) Premium Content – NOW WITH A 2 WEEK FREE TRIAL
- This Pullback May Be Different
- We Will Find Out Fast What Happens Next
- A Drop To 2860 On The S&P 500 Is A Real Possibility
- AMD May Fall 11% More
- Stock Market Comes To Critical Moment
- Stocks Set To Sell-Off Morning Commentary
- The NASDAQ Just Hit That Level Again – Midday
It has been a while since we took a look at the fundamentals of the market and where things stand. With a three weekend, it seems that this would be the appropriate time to assess the market from a valuation perspective. Overall, nobody can argue this market is fairly valued today, because it isn’t, not based on 2020 earnings, and it is hard to say it is fairly valued on 2021 earnings as well.
Currently, the S&P 500 trades for around 30 times 2020 earings of $113.75 based on estimates from S&P Dow Jones; it is also trading around 20.9 times 2021 earnings estimates of $164.01. Both of these numbers are high. When trying to adjust for the low rate environment, it gets tricky.
Some investors have tried to adjust the market for the earnings yield of the S&P 500 and the 10-year treasury. The tricky part is the earnings yield for the S&P 500 is around 3.3% for 2020 and 4.1% for 2021. The earnings yield is merely the inverse of the PE ratio. So the lower yield, the higher the PE ratio, the higher the yield, the lower the PE ratio. So I find that this method is not appropriate.
I have looked at the spread between the S&P 500 earnings yield and 10-year treasury rate. If you base it on that, we are basically in a reasonably valued region. But what is considered fairly valued appears to be more about the period, then some consistent formula. The period before 2000 was a period of high-interest rates. Therefore that spread was typically negative, while the recent period has a positive spread due to the lower rate environment.
But what seems most interesting is that from 1999 through the year 2012, falling rates did little to lift PE multiples on the S&P 500. So while it is true, there are fewer alternatives today in terms of where to put your money, falling yields did nothing to boost the valuation of the S&P 500, from a PE perspective.
In fact, rates were rising throughout 2016, 2017, and 2018, at the same we are were getting multiple expansion.
Falling and even negative interest rates did little to boost the PE ratio in Germany over the years.
It would appear that overall the movement in the market is correlated to changes and shifts in earnings trends.
We can see that more closely in the chart below with 12-month forward earnings estimates overlaid with the index itself.
It seems to suggest that if earnings trends do drive the direction of the market, and that PE multiple appears to be a reflection of future growth expectations. It may indicate the market at this point has reached its peak PE for this cycle, and multiple contraction is likely to return. It would suggest that for markets to go higher from here, we are going to need to see earnings growth return in a meaningful way in futures years.
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This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.
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