The price-to-peak earnings multiple advanced to 12.9x with Friday’s close as the market extended its recent winning streak; the S&P 500 now stands at its highest level since the September 2008 collapse of Lehman Brothers. The major indices have been range-bound of late although all are trending higher because of increased merger and acquisition activity. Over the last week, major deals have been announced in the oil and gas, basic materials, and insurance sectors. It should be noted that mergers are generally a bullish sign for stocks since it indicates that corporate management believes that good value exists in the equity markets.
As far as overall market valuation goes, earnings are steadily improving from last year, which should not surprise anyone. At its lowest point last year, trailing twelve month reported earnings for the S&P 500 had fallen 83%, mostly because of unprecedentedly huge asset write-downs. Thankfully, earnings have rebounded substantially over the last year as write-downs have tapered off. The S&P’s simple price-earnings multiple for the last twelve months stands at 23.3x, which is pretty high. It is worth noting that S&P 500 earnings remain 44% below their peak levels of August 2007. Thus, the market appears reasonably valued given current earnings levels and the potential for future growth, but it is no longer cheap unless one believes that earnings still have substantial improvement ahead.
The percentage of NYSE stocks selling above their 30-week moving average increased slightly last week to 79%. Investor sentiment remains tremendously bullish as investor moods were buoyed last week with better-than-forecast retail sales numbers. Macroeconomic data is benefiting from extremely easy comparisons from this time last year, but most economic data is improving modestly with the notable exception of employment. We believe that employment and housing will continue to be a major worry for investors.
As we noted in the blog last week, labor statistics remain extremely weak. However, suddenly, many Wall Street strategists have labeled March the month that will provide an inflection point (The March Jobs Report Better Be Fantastic). Monthly payroll
declines have moderated over the last year, and some analysts are predicting March job gains in the 250,000 to 450,000 range! Part of this glowing outlook is attributable to the temporary hiring of government census workers. Other than that, there seems to be little to back-up predictions of looming, sustained long-term employment gains. To be sure, we hope that these forecasts are correct but with this optimism about the March report rapidly becoming “conventional wisdom”, any disappointment could hit investor sentiment hard.
We continue to believe that the market is in a precarious place right now and Mohammed El-Erian described the tug-of-war as a cyclical mentality versus a structural mentality. The market’s cyclical mentality focuses on the fact that corporate earnings are recovering after a major recession, and equities appear to be one of the most attractive asset classes in a low interest rate environment. On the other hand, there are major structural concerns which are more long-term in nature. El-Erian believes that investors should become accustomed to a “new normal” which will define the next few years at least; included in this is a more budget-conscious consumer due to prolonged unemployment, increased government taxation, and slower growth ahead for the US economy in comparison to that of the emerging world.
In a way, the struggle that El-Erian describes is not a new concept as Ben Graham wrote about this dynamic back in the 1934. To paraphrase one of his best known sayings, in the short run the market acts as a voting machine but in the long run it acts as a weighing machine. El-Erian has said on many occasions that the market may have advanced further than is reasonable already, and yet, he would not bet against the market going higher in the short-term. In this case, we agree.