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Nothing To Fear But Nothing To Fear

Summary:
Strategy I: Here Comes Another Earnings Season. First, the bad news: During the 1/9 week, industry analysts estimated that S&P 500 earnings per share fell 1.7% y/y in Q4-2019 (Fig. 1). They currently estimate that earnings rose just 1.1% last year (Fig. 2). That was mostly because the comparison with 2018 was tough, as earnings soared 23.8% that year thanks to Trump’s tax cut for corporations. In addition, S&P 500 revenues per share growth was remarkably strong during 2018, rising 8.9% (Fig. 3). In other words, the S&P 500 profit margin jumped 14.9% during 2018 mostly thanks to the tax cut (i.e.,14.9% = 23.8% – 8.9%) (Fig. 4). That’s a hard act to follow, as demonstrated by 2019’s so-called “earnings growth recession.” The good news is that the outlook for 2020, both from industry

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Strategy I: Here Comes Another Earnings Season. First, the bad news: During the 1/9 week, industry analysts estimated that S&P 500 earnings per share fell 1.7% y/y in Q4-2019 (Fig. 1). They currently estimate that earnings rose just 1.1% last year (Fig. 2). That was mostly because the comparison with 2018 was tough, as earnings soared 23.8% that year thanks to Trump’s tax cut for corporations.

In addition, S&P 500 revenues per share growth was remarkably strong during 2018, rising 8.9% (Fig. 3). In other words, the S&P 500 profit margin jumped 14.9% during 2018 mostly thanks to the tax cut (i.e.,14.9% = 23.8% – 8.9%) (Fig. 4). That’s a hard act to follow, as demonstrated by 2019’s so-called “earnings growth recession.”

The good news is that the outlook for 2020, both from industry analysts and from Yardeni Research, calls for better earnings growth. Consider the following:

(1) Forward revenues at another record high. For starters, S&P 500 forward revenues per share—which is a great weekly coincident indicator of actual revenues—rose to a new record high during the 1/2 week (Fig. 5).

(2) Forward earnings uptick to record high. S&P 500 forward earnings edged up to a record high the following, 1/9 week, and the forward profit margin is holding up surprisingly well around 12%. The resilience of the margin is impressive given rising labor costs and tariff-related costs. Both cost pressures may actually ease this year if productivity makes a rebound, as I expect, and the Trump administration deescalates its trade wars.

(3) Upside surprise? By the way, forward earnings tends to be a great year-ahead leading indicator of actual earnings as long as there is no recession on the horizon (Fig. 6). Forward earnings rose to $178 per share during the 1/9 week (which will be the 1/7 week in 2021). I estimate that earnings totaled $163 per share during 2019. That implies that earnings will grow around 9% this year. That would be a nice rebound from last year’s near-zero growth rate. Joe and I still project that S&P 500 earnings will rise 5.5% to $172 per share this year, but I am considering revising our number higher (Fig. 7). (See YRI S&P 500 Earnings Forecast.)

Strategy II: Stocks Priced for Good News. Stock prices have continued to soar to new highs ever since the S&P 500 last exceeded its 9/20/18 high of 2930.75 on 10/10/19 (Fig. 8). As of Tuesday’s close, it was up 12.0% since 9/20/18 and up 39.6% from the Christmas Eve 2018 massacre low of 2351.10. It’s definitely been a meltup since then, led by the forward P/E multiple, which rose from a low of 13.5 back then to 18.5 on Tuesday (Fig. 9).

Investors have concluded that there is nothing to fear but fear itself. Last year’s worries about Trump’s escalating trade wars have abated dramatically as he deescalated them, especially the one with China. The Phase 1 trade deal with China was signed on Thursday. Additionally, the Fed reversed course last year. Instead of raising the federal funds rate three or four times, it was cut three times. Trump undoubtedly will claim bragging rights for this pivot since he harangued the Fed to do just that.

When Trump took executive action against the top Iranian general on Friday 1/3, the stock market flinched on Monday 1/6, but then resumed its climb to record highs. Therefore, I am NOT adding this event to my diary of panic attacks during the current bull market, for now. (See my Table of S&P 500 Panic Attacks Since 2009 and the related chart book.)

The Iranians did retaliate with a missile attack on a US military base in Iraq. However, no one was killed, though there were a few injures, contrary to preliminary reports. Trump may have convinced the Mullahs that he is willing to obliterate their regime if they attack Americans and America’s allies anywhere in the world. Meanwhile, pro-Mullah demonstrations in the streets of Iran have been followed by widespread anti-Mullah protests. The Mullahs are cornered. In the past, they might have unleashed chaos in the Middle East to deflect attention from their internal crisis, which has been greatly exacerbated by Trump’s sanctions on Iran. Now, they might be loath to pick a fight with Trump, maybe.

While roughly half the country hates Trump, nearly all Democrats hate him, believing that he is the Devil incarnate or at least deranged. (The President also has an uncanny ability to trigger “Trump Derangement Syndrome” among his adversaries.) His supporters see him as a great dealmaker, using the economic and military power of the US to make trade and geopolitical deals that benefit the US.

Love him or hate him, the question for those of us who invest is whether Trump is bullish or bearish for the financial markets. The answer is obvious: The markets believe that there is method in his madness. The S&P 500 is up 53.4% since Trump was elected president (Fig. 10). It helps that the President keeps talking up the stock market, which he seems to view as his most important popularity poll.

I think it’s reasonable to assume that the markets expect that Trump will be reelected. If so, that will be bad news for his opponents. For investors, it could be good news. However, I am concerned that there is nothing to fear but nothing to fear. If the meltup continues, then the stock market’s valuation multiple will rise toward nose-bleed levels. If that sets the stage for another meltdown correction like the one during Q4-2018, it would probably be yet another buying opportunity and not the end of the bull market. It’s credit crunches, which lead to recessions, that cause bear markets.

So for now, we have nothing to fear but nothing to fear.

One final note on this subject: My job is to be an investment strategist. I do “bullish” or “bearish.” I’m not a preacher. I don’t do “good” or “bad.” So all I am saying is that Trump has been bullish for the stock market and is likely to remain so. If you would prefer not to give him any credit for the bull market, you can give it all to the major central banks. I have been predicting since last fall that the latest round of easy money being provided by the major central banks could cause a meltup in the US stock market. See for example the 11/3/19 CNBC interview with me titled “A ‘market melt-up’ is becoming a real risk as stocks hit new highs, Wall Street bull Ed Yardeni warns.”

Recall that President Barack Obama also was not loved by all. However, anyone who stayed out of the stock market because of their political antipathy for the President missed a great bull market. The S&P 500 rose 140.3% under Obama mostly because the Fed pursued ultra-easy monetary policies (Fig. 11).

Obama certainly wasn’t as much of a cheerleader for the stock market during his administration as Trump has been during his. However, Obama was a great investment strategist. On 3/3/09, Obama told reporters: “What you're now seeing is [price-to-earnings] ratios are starting to get to the point where buying stocks is a potentially good deal if you've got a long-term perspective on it.” At the time, the forward P/E was 10.5. That was truly a great call. I came to the same conclusion later that same month.

Strategy III: Valuations Soaring. In my analysis above, I focused on the forward P/E. It’s at a cyclical high, though still well below the tech bubble high of 25.7 on 4/12/99. Nevertheless, if you are looking for trouble, then you’ll find it in the S&P 500 forward price-to-sales ratio (P/S) (Fig. 12). It is simply the S&P 500 stock price index divided by forward revenues. Previously, I demonstrated that it very closely tracks the Buffett Ratio, which is the US equity market capitalization excluding foreign issues divided by nominal GNP (Fig. 13).

The forward P/S rose to a record high of 2.2 during the 1/2 week. That exceeds the tech-bubble peak in the Buffett Ratio at 1.9 during Q1-2000. Here’s another outlier: The PEG ratio—which is the forward P/E of the S&P 500 divided by analysts’ consensus expectations for long-term earnings growth at an annual rate over the next five years—also soared to a record high during the 1/2 week (Fig. 14).

Again: We have nothing to fear but nothing to fear other than high valuation multiples.

Dr. Ed Yardeni
Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research for institutional investors. In this blog, we highlight some of the more interesting relationships and developments that should be of interest to investors. Our premium research service is designed for institutional investors.

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