Stock market valuations may be considered the ultimate in fundamental measures, but they can just as easily be considered long-wave sentiment indicators. What causes equity investors to pay as little as 10x for S&P 500 Normalized Earnings at one point (March 2009), but pay more than 30x a dozen years later? The Fed printing press was in overdrive at both points; only emotions can account for the difference.
Cap-weighted valuations for the S&P 500 and S&P Industrials are homing in on the all-time records seen in the first quarter of 2000. We’ll confess that after those valuations collapsed in the years that followed, we thought we’d never see them again in our lifetime—let alone a mere generation later.
Last spring and summer, we were incorrectly skeptical that a new bull had been born only five weeks after the death of oldest bull ever. But be careful with labels. Just as the “bear market” mindset caused us to overplay our hand last spring, equity bulls should not assume the current bull will look anything like the decade-long affairs we’ve seen twice in the last 30 years.
Driven by massive government stimulus, an imminent vaccine rollout, and the expectation of record earnings in 2021, investors seem to be on the verge of embracing a move away from Large Cap Growth stocks in earnest. The leading candidates offered as broad-based alternatives to Large Growth (LG) include Value, Small Caps, and Emerging Markets.
Mid and Small Cap stocks underperformed in 2018 and 2019. However, after the collapse of February and March, these “SMID” Caps have largely kept pace with the torrid rebound in the blue chips. Today’s valuations are priming the SMIDs for a similar “decoupling” in the years ahead, like that following Y2K.
The first up-leg of the bull market has catapulted many Large Cap valuations to levels seen only in 1999, 2000, 2019, and pre-pandemic 2020. At the six-month point on September 23rd, the S&P 500 P/E on 5-Yr. Normalized EPS had already reached 26.9x—a reading that is 30% higher than at the same point of any other bull market.
The strong market rebound in the second quarter lifted the relative return of Growth vs. Value to an all-time high by the end of June. Chart 1 reveals that the cumulative S&P 500 Growth / Value return spread hit a new record last month, surpassing the previous high reached at the end of the Tech bubble in June 2000.
How does one value a stock market in which 12-month forward EPS estimates show their widest dispersion in history? A good start might be with methods we use when forward estimates show practically no dispersion (like three months ago). In either case, we place little weight on such estimates; each revision usually has only marginal impact on our 5-Year Normalized EPS.
A composite measure of Mid Caps and Small Caps are at bottom-decile valuations relative to their 26-year histories. From a shorter-term viewpoint, though, we find it scary that valuations are so low just a single month into the recession.
The coronavirus epidemic/pandemic is getting the bulk of the blame for the sudden collapse in U.S. equities, and certainly qualifies as one of the few “black swans” seen in modern market history. We do not think the ultimate path of the coronavirus contagion can be analyzed at this point, and medical experts foresee possible outcomes ranging from a serious epidemic to a short burst of illness that fades with the summer weather.
With 2020 representing The Leuthold Group’s 40th year of publishing Perception For The Professional, we perused the first few Green Books for relevant nuggets from 1981, but the backdrop could not have been more different. Therefore, we instead turned the clock back 20 years, thinking it might yield insights more resonant with today’s environment.