Markets remain on the slight expensive side, but it’s mostly because of higher rates. But we are very close to fully pricing in the terminal rate of Fed funds and weakening of the economy and earnings should start to balance out. The tightening of financial conditions is likely to continue in the short run. The earnings yield of the S&P 500 increased 8.0bps. The yield of the 30-year bond increased 15.0bps. Overall, the ERP declined 6.9bps last week. The inverse of the P/E called the earnings yield plus the long-term government yield is a reasonable estimate. The equity risk premium is the discount factor investors are paying for stocks above the risk free rate. While the market is expensive historically, this metric suggests returns will be well below average and should not be used as a timing indicator, but adds to the cautionary environment. The rate of EPS change is rising but still good relative to nominal GDP expectations.Ī reading near 90% historically means the average returns over the coming years will likely be well below average. Over the past 3 months, forward EPS estimates have decreased by -2.27%. Over the past month, 12-month forward EPS estimates have decreased by -0.92%. The historic average P/E for US large caps is about 16.5x earnings versus the current forward P/E of 16.00. Analysts are often too optimistic on forward expectations.Forward P/Es historically are 2 multiple points below trailing average. Earnings expectations are a key factor for market growth. While the forward P/E is well below average, historically, this metric suggests longer-term returns could be above average, it should not be used as a timing indicator due to reliability of forward expectations. This should negatively impact EPS going forward.Ī reading near 20% historically means the average returns over the coming years may be above average. With nominal growth still strong, revenue growth is still likely, but margin pressures are building and volumes are already in decline. With several recessionary indicators now fully flashing high risk, decay in the employment picture would cement an earnings recession. ![]() Many industries have higher margins, so price-to-sales is not a perfect guide. The revenue a company generates is less subject to manipulation (financialization) like earnings per share can be and can be a better valuation metric than comparisons to earnings. ![]() Longer-term returns in this environment are likely to be about average, but short-term returns will likely trend in the current direction. While not compelling given the recession risks still to play out, these are the best valuations since the COVID lows.Ī reading near 50% historically means the returns over the coming years will likely be about average. Earning before interest taxes depreciation and amortization (EBITDA) has improved significantly over the past year while recent weakness in stocks and bonds has lowered EV. Enterprise value (EV) is the amount of debt plus equity capital a company uses less cash like holdings to generate free cash flow. Valuation metrics are not great timing indicators, but looks to frame longer-term expectations and magnitude of a correction when a catalyst develops. Q3 earnings season so far better than expected.Ī reading about 40% historically means the average returns over the coming years will likely be modestly above average. Suggests rallies are to be rented for now and lower lows are likely with earnings decay as the next phase. If we are heading for recessions as our business cycle indicators are suggesting, than we are still slightly above average and the ERP is slightly elevated given where rates are likely to stay for a while. Valuations overall are about average if one believes that forward based EPS are reasonable. It will be easy for the Fed to get inflation from 9% to 5%, but from 5% back to 2% will be WAY WAY WAY more difficult without breaking something. ![]() We see sticky inflation building, which should be tough for most asset markets. Lower P/E stocks, more value and earnings quality makes sense for the next few years. If a cyclical bear market is beginning given the difficult job that central banks have for the next few years, the longer-term bias has to be towards selling rallies and positioning portfolios as boring as they can be. Jump to section: Valuation | Business Cycle Factor | Tactical Factor
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