Betting on a Boom

August 21, 2019

The stock market is supposed to be "efficient", which means it is pricing in the current value of all future earnings for the component companies. Of course, nobody knows what those future earnings will be, so we often see wide swings between investors who are overly optimistic and overly pessimistic. Small news items (like tweets from the President) cause market participants to adjust rapidly their future expectations.

 

At SEM, we do not believe the market is efficient and instead represents the consensus feelings of market participants. If participants are feeling optimistic they will buy stocks and prices will rise. If they are pessimistic they will sell and stock prices will fall. All of the indicators we utilize are mechanical in nature and designed to measure the ebbs and flows of investor sentiment, rather than guessing about what will happen to corporate earnings. I still cannot fathom how corporate managers and Wall Street analysts can predict what earnings will look like in 3 months let alone for the next two years. Yet for some reason market participants use these numbers with confidence.

 

One thing I find interesting is to look at the components of stock market growth. Stock returns can be broken down to growth in earnings, growth in dividends, and "multiple expansion." Stocks SHOULD go up if earnings and dividends are growing, but that is not always the case. Multiple expansion is by far the most volatile component of returns. Essentially it is how much investors are willing to pay for a dollar of earnings. If investors are betting on a boom, the multiple will go up and drive prices higher. If investors are less certain, multiples will fall and prices will drop.

 

2019 has seen some of the best returns for stocks during this entire 10+ year bull market. I would be more excited if this was due to some impressive earnings growth numbers. Instead, nearly all of the returns for the S&P 500 have been due to "multiple expansion." (h/t to Babak @TN who has some great charts on his Twitter feed)

ILLUSTRATIVE PURPOSES ONLY -- PLEASE SEE DISCLAIMER AT BOTTOM OF PAGE
 

Going into the year, the S&P 500 P/E ratio was 19.6. It currently is 21.8. If we multiply that 2.2 point jump in the P/E ratio by the S&P 500 earnings we see a jump of 340 S&P 500 points (or all but a few of the points gained). What I'm concerned about is the fact the market is not expecting any sort of slowdown in earnings growth. In fact, analysts are expecting a strong acceleration in growth in 2020.

ILLUSTRATIVE PURPOSES ONLY -- PLEASE SEE DISCLAIMER AT BOTTOM OF PAGE
 

Given our economic model's continued warning signs about growth and the huge jump in the P/E multiple the market is very susceptible to a double whammy --- slower than expected earnings growth and a contraction in the P/E multiple. If you're in a buy & hold strategy I'd be VERY cautious at this point.

Please reload

Featured Posts

Investment Grade Junk

September 11, 2019

1/10
Please reload

Recent Posts

November 13, 2019

November 6, 2019

October 10, 2019

September 26, 2019

Please reload

Connect
  • LinkedIn Social Icon
  • Twitter Social Icon
  • Facebook Social Icon
  • RSS Social Icon

Related Posts

Please reload

This site is for INFORMATIONAL PURPOSES ONLY.  The comments and posts published in the SEM Trader's Blog ARE NOT investment recommendations. They can NEVER be considered as trading calls or advices. If you decide to use the information offered here for your real trading it is at your own risk.  CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute

Investing in the stock or bond markets involves risk and may not be suitable for all investors. Before making any investment decisions you should carefully consider your investment objectives, level of experience and risk appetite. The possibility exists you could sustain a loss of some or all of your initial investment and therefore you should not invest money you cannot afford to lose. You should be aware of all the risks associated with your investments and seek advice from an independent financial advisor if you have any doubts. All investments involve risk including those managed by SEM Wealth Management.

Opinions expressed at www.stratequity.com, www.semwealth.com and semtradersblog.com or the previous Trader's Blog site are those of the individual authors and do not necessarily represent the opinion of SEM Wealth Management or its management. Any opinions, news, research, analysis, prices or other information contained on this website, by SEM, its employees, partners or contributors, is provided as general market commentary and does not constitute investment advice. SEM will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

 

The use of this website constitutes acceptance of our user agreement. Past performance is NOT indicative of future results.

***Anywhere performance of SEM's Investment Models is used, please refer to our Performance Snapshot  which contains details of the performance calculations for each of our investment models.***

 

There is no representation made as to the future results of SEM’s programs or if they will be profitable.

For additional information on the author and SEM Wealth Management, please see our DISCLOSURE DOCUMENT (ADV Part 2).