Stocks are about to face a new concern



The Dow 30 Industrials, S&P 500 and Nasdaq Composite all closed at record highs on Friday. Markets are climbing proverbial “wall of worry” with concerns over Fed announcement of phase-down program next week, Delta variant still impacting economy, supply chain issues affecting businesses, fears that inflation will stay at a high level longer than expected and significant additional spending by the federal government. For the week, the Dow, S&P 500 and Nasdaq rose 0.4%, 1.3% and 2.7%, respectively.

However, investors can take this into account and to some extent have adjusted the valuations they are willing to pay, as the 12-month PE multiple of the S&P 500 fell from around 23 a year ago to 21 currently. Another hurdle investors will face is slowing earnings growth next year.

The S&P 500 at an all-time high

The S&P 500 closed at a record high of 4,605.38 on Friday. It weathered a tough September and rose 11 of the last 13 trading sessions. After dropping below its daily moving averages of 50 and 100, the blue and red lines in the chart below, it has risen significantly above its 50-day moving average and is in a fairly significant overbought state. , as indicated by its RSI or Relative Strength index of 68.49, the upper part of the graph.

Spread between stocks and earnings

The chart below by John Butters, Senior Earnings Analyst at FactSet, helps to illustrate the increase in valuations attributed to stocks over the past 10 years. Although the placement of the scales and lines is arbitrary, it shows that the S&P 500 traded at a lower valuation for the first three years, then online for about five years, then rose sharply for the last 18 years. month. The steepness of the curve from the pandemic earnings trough helps explain the increased valuations over the same period.

Strong EPS growth drove equity valuations down

However, what has also happened is that the PE multiple of the S&P 500 has declined slightly over the past 15 months. One of the main reasons is that analysts’ estimates tend to lag behind the outlook for companies. They are too positive when the economic environment deteriorates and too negative when the economy and earnings rebound.

While the current PE ratio of around 21 is still above the 5 and 10 year averages, one of the keys to maintaining a higher valuation is how aggressive the Fed is with its gradual reduction in asset purchases. and when it will start raising interest rates.

BPA growth will slow down considerably

While investors know it is coming, the cold water in the face of slowing earnings growth has not been fully highlighted. The results for the September quarter will be completed in the coming weeks and those for December should also be good.

Butters at FactSet estimates earnings growth will drop to single digits for the first three quarters of next year and barely reach half of the December 2021 growth rate in the fourth quarter of next year. This should come as no surprise since earnings growth in 2022 will compete with the tough comparisons of 2021. However, it is a concern that could stumble the stock market.

  • 3Q 2021: Increase of 36.6%
  • 4Q 2021: Increase of 21.6%
  • 1Q 2022: up 5.8%
  • 2Q 2022: up 8.6%
  • 3Q 2022: up 8.5%
  • 4Q 2022: up 12.4%

Profit margins close to historic highs

Butters also estimates that the net profit margin of S&P 500 companies could reach 12.8% in the March quarter, the second highest margin since FactSet started tracking this metric in 2008. It also fell from 12.8%. 3% just two weeks ago.

It has analysts projecting margins of 12.1%, 12.5% ​​and 12.8% for the fourth quarter of this year and the first and second quarters of next year, respectively. It would not be surprising to see the margins shrink.

Smaller width

A technical indicator that investors follow is how many stocks are rising versus falling trends or how many are reaching new highs versus new lows. Since early July, the percentage of stocks trading above their daily moving average of 200 has fallen from around 92% to 72% currently. As stock indices hit new highs, this indicates that it is fueled by a small number of stocks. Technical investors prefer to have more participants in case the few leading the charge weaken.

The market is complacent

As the stock markets have hit new highs, investors are getting complacent about any large declines as measured by the VIX or the Volatility Index. When it drops and is at low levels, like currently at 16.26, it means that if something unexpected happens it could have a bigger downward impact than normal.



About Author

Leave A Reply