starting out in 2020

The S&P 500 is trading at about 25x current earnings, with 10% eps growth in prospect, implying the market is trading at around 22.7x forward earnings.  During my working career, which covers 40+ years, high multiple/lower growth has virtually always been an unfavorable combination for market bulls.

Could the growth figure be too low, on the idea that forecasters give themselves some wiggle room at the beginning of the year?

For the 50% or so of earnings that come from the US, probably not.  This is partly due to the sheer length of the expansion since the recession of 2008-09 (pent up demand from the bad years has been satisfied, even in left-behind areas of the country–look at Walmart and dollar store sales).  It’s also a function of shoot-yourself-in-the-foot Washington policies the have ended up retarding growth–tariff wars, suppression of labor force expansion, tax cuts for those least likely to consume, no infrastructure spending, no concern about education…  So I find it hard to imagine positive surprises for most US-focused firms.

Prospects are probably better for the non-US half.  How so?  In the EU early signs are emerging that structural change is occurring, forced by a long period of stagnation.  The region is also several years behind the US in recovering from the recession, so one would expect that the same uptick for ordinary citizens we’ve recently seen in the US.  Firms seeking to relocate from the US and the UK are another possible plus.  In addition, Mr. Trump’s life-long addiction to risky, superficially attractive but ultimately destructive, ventures (think:  Atlantic City casinos) may finally achieve the weaker dollar he desires–implying the domestic currency value of foreign earnings may turn out to be higher than the consensus expects.

 

The biggest saving grace for stocks may be the relative unattractiveness of fixed income, the main investment alternative.  The 10-year Treasury is yielding 1.81% as I’m writing this  That’s 10 basis points below the dividend yield on the S&P 500, which sports an earnings yield (1/PE) of 4.  I say “may” because, other than Japan, the world has little practical experience with the behavior of stocks while interest rates are ultra-low.  In Japan, where rates have flirted with zero for several decades, PE ratios have declined from an initial 50 or so into the low 20s. Yes, Japan is also the prime example of the economic destructiveness of anti-immigration, anti-trade, defend-the-status-quo policies Washington is now espousing. On the other hand, it’s still a samurai-mentality (yearning for the pre-Black Ship past) culture, the population is much older than in the US and the national government is a voracious buyer of equities.   So there are big differences.  Still, ithe analogy with Japan holds–that is, if the differences don’t matter so much in the short term–then PEs here would be bouncing along the bottom and should be stable unless the Fed Funds rate begins to rise.

That’s my best guess.

 

The consensus was of viewing last year for the S&P is that all the running was in American tech industries.   Another way of looking at the results is that the big winners were multinational firms traded in the US but with worldwide markets and very small domestic manufacturing and distribution footprints.   They are secular change beneficiaries located in a country whose national government is now adamantly opposing that change.  In other words, the winners were bets on the company but against the country.  Look at, for example,  AMZN (+15%) vs. MSFT (+60%) over the past year.

The biggest issue I see with the 2019 winners is that on a PE to growth basis they seem expensive to me.  Some, especially newer, smaller firms seem wildly so.  But I don’t see the situation changing until rates begin to rise.

 

Having said that, low rates are an antidote to government dysfunction, so I don’t see them going up any time soon.  So my practical bottom line ends up being one of the gallows humor conclusions that Wall Streeters seem to love:  the more unhinged Mr. Trump talks and acts–the threat of bombing Iranian cultural sites, which other governments have politely pointed out would be a war crime, is a good example–the better the tech sector will do.  As a citizen, I hope for a (new testament) road-to-Damascus event for him; as an investor, I know that would be a sell signal.

 

 

 

 

 

 

 

 

thinking about 2020

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

 

 

 

 

Keeping Score, November 2019

I’ve just updated my Keeping Score page for November.  Given the absence of mutual fund selling in October, not a bad result.

Keeping Score, September 2019

I’ve just updated my Keeping Score page for September 2019.  No sign so far of the traditional actively-managed mutual fund selloff in advance of the Halloween yearend.  I wonder why.  Is this a function of the AI era?   …the fact that passive money under management exceeds actively managed?   …is selling just late?

Will no selloff now mean no 4Q rally?    …that would be my guess.