where we are
The S&P 500 is trading at around 25x current earnings, up from a PE of 20x a year ago. Multiple expansion, not earnings growth, is the key factor behind the S&P rise last year.In fact, earnings per share growth, now at about +10%/year, has been decelerating since the one-time boost from the domestic corporate income tax cut cycled through income statements in 2018. Typically earnings deceleration is a red flag. Not so in 2019.
EPS growth in 2020 will probably be around +10% again.
About half the earnings of the S&P come from the US, a quarter from Europe and the rest from emerging economies. The US will likely be the weakest of the three areas this year, as ongoing tariff wars take a further toll on agriculture and manufacturing, as population growth continues to wane given the administration’s hostility toward foreigners, and as multinationals continue to shift operations elsewhere to escape these policies. On the other hand, Europe ex the UK should perk up a bit, emerging markets arguably can’t get much worse, and multinationals will likely invest more abroad.
interest rates: the biggest question
What motivated investors to bid up the S&P by 30% last year despite pedestrian eps growth and Washington dysfunction?
Investors don’t buy stocks in a vacuum. We’re constantly comparing stocks with bonds and cash as alternative liquid investments. And in 2019 bonds and cash were distinctly unattractive. The yield on cash is close to zero here (elsewhere in the world bank depositors have been charged for holding cash). The 10-year Treasury started 2019 yielding 2.66%. The yield dipped to 1.52% during the summer and has risen to 1.92% now. In contrast, the earnings yield (1/PE, the academic point of comparison of stocks vs. bonds)) on the S&P was 5% last January and is 4% now.
The dividend yield on the S&P is now about 1.9%. That’s higher than the 10-year yield, a situation that has occurred in our lifetimes only after a bear market has crushed stock valuations. In my working career, this has happened mostly outside the US and has always been a clear buy signal for stocks. Not now, though–in my view–unless we’re willing to believe that the current situation is permanent.
The situation is even stranger outside the US, where the yield on many government bonds is actually negative.
In short, wild distortions in sovereign bond markets, a product of unconventional central bank measures aimed at rescuing the world economy after the 2008-09 collapse, have migrated into stocks.
How long will this situation last and how will it unwind?
more on Monday