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Stocks continue to march higher with the S&P 500 now up by 19% in 2019. But let’s not fool ourselves, because, since January 26, 2018, the S&P 500 is up only 4%. Pretty pathetic if you ask me for a nearly 18-month showing. That comes despite operating earnings climbing to $153.05 on a trailing twelve-month basis through the end of the first quarter from $124.51 in the fourth quarter of 2017, a gain of over 22%.
Its no wonder why the S&P 500 is trading at 18.3 times 2019 earnings and 16.3 times 2020 earnings according to data provided by S&P Dow Jones. They currently estimate operating earnings of $163.60 for 2019 and $183.74 for 2020.
The one drag on the S&P 500 continues to be the slow decline of earnings estimates for 2019 and 2020. Since the beginning of the year, earnings estimates for 2019 have fallen by 4%, and since their peaks have dropped by over 7%. Meanwhile, 2020 earnings have fallen by almost 5% since the start of the year.
The declining earnings estimates have been the primary reason until now, why we haven’t seen significantly higher equity market. The constant drag lower in earnings estimates. However, the low rate environment is likely to give us the multiple expansion needed to offset the declining earnings estimates.
That is why the market is heavily counting on a Fed rate cut, and why if the Fed doesn’t start cutting rates, it could be a big problem for stock. The low-interest rate environment makes stocks too hard to ignore. The chart below shows that the spread between the S&P 500 dividend yield and the 10-year treasury rate is a historically low level.
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The last time this event happened was in 2009, 2011, and 2016. Those were times of significant market turmoil, not that different from the past 18 months for the S&P 500.
Not only that, but 2011 and 2016 were periods of consolidation which lasted for, you guessed it, about 18 months. Sound familiar?
It could very well, mean the S&P 500 is nearing a potentially significant turning point. As yields fall, dividend yields will fall. That means prices rise, and that means the value of the S&P 500 will increase.
It also means that more money will flow into areas of the stock market that can yield the highest returns in the future, which is perhaps why semis, technology, materials, and biotech were the best performing sectors in June while technology and communications continue to lead the way higher to start the month of July.
There is a significant change occurring in the equity market. The period of consolidation is over, and the lower rate environment is about to push the stock market much higher.
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.