A Higher P/E Ratio Results In A Great Year For Stocks

by | Dec 3, 2019 | Recent Commentary |

A Higher P/E Ratio Results In A Great Year For Stocks

 

A Higher P/E Ratio Results In A Great Year For Stocks

  • This year’s 25%+ YTD advance in the S&P 500 stock index is a very pleasant surprise to most investors.  What accounts for the great year in stocks?  About 20% appreciation came from multiple expansion (a higher P/E ratio on the stock market).  Add 3% from earnings growth and 2% for dividends.  Can we have another stellar year in 2020?  It is unlikely in our view.  P/E ratios are rich with probably little room to go higher, even with low interest rates.  And they may go down with any disappointments such as lack of progress on trade issues.  Next year’s stock returns are more likely to be tied to earnings growth which is now forecast at a very respectable 7-9%.  Add 2% for dividends and, despite what the skeptics say, 2020 could be a solid year.  Of course there are pitfalls (there always are), but sometimes investors lose sight of what could go right.
     
  • Money supply is growing faster than the economy leaving lots of excess liquidity for financial markets.  A lot of that monetary growth represents money-market funds, which now total $3.6 trillion, up 22% from a year ago, and close to the peak of $3.9 trillion hit in March 2009 (the bottom of the bear market).  These high current cash levels are an indication that we are far from the euphoria stage that usually signals a bull market top.
     
  • Here are a few concerns we have:  First, in spite of a strong consumer (lots of jobs created, wage gains, high confidence, and robust spending), why are consumer stocks lagging so far behind the S&P 500 lately?  What does the market know that investors don’t?  Following is a one-year graph that shows the relative performance of consumer discretionary stocks.  A rising line means that consumer discretionary stocks are outperforming the S&P 500 index.  A falling line means they are under-performing.  The graph shows significant under-performance of consumer stocks since July (about 8%). 

Source:  Bespoke Investment Group

  • Our second concern is for the first time the valuation of U.S. equities is 1.5 times our GDP (other valuation measures are not at this extreme level).  At the same time, corporations have increased their debt load by about 60% in the past 10 years, and now totals about $16 trillion.  Does this mean there will be numerous defaults in the next recession making the downturn even worse?
     
  • After a rough year two, President Trump’s market returns during the Presidential Election Cycle have come roaring back in year three-see below.  Overall returns for President Trump have now doubled the average at this point in the cycle.

Source:  Bespoke Investment Group