As we are close to wrapping up Q2 earnings, I need to put things into perspective as that is what I do. We hear all the time that the stock market is doing well because earnings are good but years of gains in stocks have been driven more by multiple expansion.
In 2013, earnings were up about 15% GAAP and 11% non GAAP but the S&P 500 rallied north of 30%. Thank you global QE Infinity. Assuming 10% earnings growth in 2017, earnings since Q4 2013 will TOTAL 16% GAAP and 19% non GAAP and since then while the S&P 500 is up about 35%. Taken together, the S&P 500 is up 74% since December 31st 2012 while GAAP earnings are up 35% and non GAAP earnings are up by 32%.
Thus, we’ve priced in the current earnings improvement twice over. This then begs the question of what happens to multiples when QT starts followed by ECB tapering. Predicting futures P/E ratios has as much to do with forecasting psychology as it does interest rates and inflation. So never easy. I’ll just predict that multiples are more likely going down than either staying unchanged or moving higher. Therefore, earnings better accelerate much further from here to offset that. That then will be determined by whether faster revenues can offset higher labor costs and lower profit margins.
I’ll repeat again, we are in the midst of a change in global monetary policy, no matter how gentle and gradual it is. This at the same time the price to sales ratio of the S&P 500 is at a record high if we take out a few weeks in March 2000. If lunch is free, markets will be ok. If lunch is never free, then…
I wrote a few months ago my frustration as a value investor and titled my piece The Death of the Value Investor. In case you didn’t see, the front page of the Business & Finance section of today’s Wall Street Journal has an article titled Hot Stock Rally Tests the Patience of a Choosy Lot: Value Investors. It went on to say:
“Value investing is mired in one of its worst stretches on record, prompting concerns that the investment style favored by generations of fund managers is losing its effectiveness.”
As an adherent of the front page magazine/newspaper effect where after it gets to front page news, a trend change in the opposite direction is about to occur, maybe this time will be the case again.
Of note overseas, German industrial production in June fell 1.1% m/o/m instead of rising by .2% as forecasted. This is the first decline since December. This follows a better than expected factory order number last week which was driven solely by domestic demand. The German Economic Ministry didn’t sound worried as they said “Factory orders as well as indicators for business climate point to the upward trend in industrial production continuing.” I’ll give the German economy the benefit of the doubt and wait another month or two before drawing any firm conclusions. The euro didn’t flinch as it’s up against the dollar and why the DAX is down by .5%. German bund yields are little changed.
China said its FX reserves in July totaled $3.081T, higher for a 6th straight month, up from $3.057T in June and higher than the estimate of $3.075T. A broadly weaker US dollar has certainly helped stem the outflows on top of the controls already in place. We also know that the massive foreign M&A deals of Chinese companies buying anything in sight overseas has cooled down dramatically. The yuan, both onshore and offshore, rallied in response to the data. Both the A share and H share indices were up about .5% overnight. At least for now, the Chinese authorities got the stabilization in both their currency and FX reserves that they wanted.