HomeBlogOptimism Reigns Supreme in U.S. Equity Markets

Don’t confuse the equity market rise with positive fundamentals from stocks. Since 2013 earnings for the S&P 500 have gone from $107.3 to $113.01 to $106.32 and in that time the S&P 500 rose from 1,848 to 2,044.1  This had the effect of increasing the market’s P/E ratio from 17.2 to 19.2, meaning that on average, investors are now paying a higher price for lower earnings. Granted most of the fall in earnings stemmed from energy and materials companies, but that doesn’t discount the fact that the market multiple (P/E ratio) is rising as analysts are forecasting a strong rebound in earnings for U.S. companies.

Below is one of our favorite charts. It shows the earnings expectations that analysts set at the beginning of each year going back to 2012 and then how those estimates actually panned out. For example, looking at the black line representing 2012, we can see that in March of the prior year analysts were beginning to predict what the earnings on the S&P 500 would be by the year end of 2012. Analysts’ initial predictions were that earnings would expand by nearly 12 percent over the previous year. What happened? Well, by the time the year came to an end, earnings only grew 5.1 percent.


For some reason this happens nearly every year; an overly optimistic outlook eventually succumbs to reality. Looking at the early estimates for 2017 as shown by the purple line, as of the end of March, analysts were expecting the S&P 500 to have an earnings jump of 13.4 percent from 2016. We wonder how long it will be until those estimates are revised down.

U.S. equity valuations are indeed stretched; maybe not to bubble territory, but they’re certainly above any level that we would deem cheap or attractive. The problem is there aren’t many investable places where assets aren’t expensive. The bond market, in particular, is quite worrisome to us. With $11 trillion in global bonds having negative yields, certain sectors of the bond market are at risk of a selloff – namely sovereign or government bonds.2  In other sectors such as high yield bonds, yields keep getting pushed down as investors constantly search for anything that will provide a decent level of income, even if fundamental factors are signaling warning signs.

Switching course and skipping ahead to the November elections, as this seems to be a topic on many clients’ minds, we believe there could be some near term volatility. But over the medium to long term whoever is president shouldn’t have a material impact on the performance of the broader market. I’ve mentioned this before, but I think it bears repeating; the stock market typically cares about four things:

• Where are we in the business cycle?
• What are the expectations for company’s profits going forward?
• What are inflation expectations?
• Where are interest rates going – and of course, how will the Fed react to these four factors?

Notice I didn’t mention the presidency in there. The elections could most certainly cause some near term volatility, but the best course of action in our opinion is inaction.

1. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/spearn.htm
2. http://www.cnbc.com/2016/08/09/bonds-and-debt-negative-yields-are-doing-the-opposite-of-what-they-were-intended.html
If you or a family member encountered a sudden situation that posed  immediate risk,
would you be ready and able to take the appropriate course of action?

DOWNLOAD Preparing for Emergencies HERE!