Written by Lance Roberts, Clarity Financial
I have seen too much commentary as of late suggesting that since the Fed is lowering rates, then valuations should be higher.
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My friend Doug Kass penned an excellent piece on this last week.
“Price is what you pay, value is what you get.”- Warren Buffett
“The stock market is not expensive if you believe two percent fed funds and two percent ten-year governments… In the last fifty years when the market multiple averaged 15x and the ten year government was 6.5% and is now 2.00% the fed funds was five and is currently two. The multiple is ten percent higher today than historically but rates are a third of historical levels.”- Lee Cooperman,
I argued that comparing equities to bonds – which almost everyone recognizes to be an overvalued asset class (especially in an intermediate term sense) – represents a slippery slope to support current and elevated stock valuations. I went on to suggest to Lee that stocks don’t deserve a higher multiple for lower interest rates if the reason for lower rates is slower growth.
Again, second-level thinking might be called for. Lee went on to point out (with the assistance of his partner and my old pal Steve Einhorn) that 2Q 2019 S&P earnings, previously expected to decline by about 2%-3%, should now show a small increase. Steve and Lee are forecasting 2019 S&P earnings of $168/share. Here I would point out that we started the year with consensus S&P EPS above $172/share – so Lee’s $168/share estimate is lower, during a time in which S&P prices rose by over +20%.
As noted by Peter Boockvar (in the chart of the S&P 500 Index and the consensus 2019 earnings estimates) and as I noted in my column – price-earnings multiples have advanced in 2019 (from 14.5x to 17.5x) without ANY growth in S&P earnings.
In fact, the 2019 S&P EPS estimates have been continually downgraded throughout the first seven months of this year (I remain at around $160/share, and that’s where I was since November, 2018).
S&P 500 price in yellow, S&P earnings estimate in white ($165.60, a new low for the year)
Here is the point:
“Low rates can justify higher valuations IF everything else is growing ‘organically.’ When valuations are high due to low rates being used for leverage to make up for slow growth, then higher valuations are not justified.”
The Fed is Pushing on a String – and a meaningful market decline might lie ahead once investors realize that the cost and availability of capital is not what is holding back the global economy.
For now, the best course of action remains a “wait and see” approach. We continue to carry an overweight position in cash, fixed income, and rate hedges, and an underweight exposure to risk equities.
I will be back next week.
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See you next week.
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