Jan 9, 2020

The S&P 500 could be overvalued

The New York Stock Exchange on Jan. 8. Photo: Xinhua/Wang Ying via Getty Images

The S&P 500 is too rich on a number of levels, according to calculations in a new paper from Ned Davis Research that examines the index's price to earnings, profits and price to sales.

What's happening: Not only is the benchmark stock index's current P/E ratio "well above fair value," S&P companies' prices relative to sales is at a record high, “well in excess of what they were in 2000 or 2007 at those peaks,” Ned Davis, the company's senior investment strategist, says in a note to clients.

Why it matters: Most Wall Street analysts predict that even after earnings declined overall and prices rose 30% in 2019, U.S. equities will rise modestly this year, by around 5%. But Davis warns "the long history of valuations tells me that over long-term periods, prices tend to revert to or below fair values."

  • That would mean earnings would need to increase significantly or equities prices would need to fall.

Further, "[T]he S&P 500 could be overstating earnings due to buybacks and other financial engineering of profits,” Davis says. "S&P 500 earnings have done much better than overall corporate profits for the last five years."

  • "Other measures, like the median price to earnings ratio — which exclude the skewed effects of very profitable and very unprofitable companies — shows the S&P 500 overvalued by nearly 30% versus the typical valuation level seen since 1964."
  • And “P/E ratios are some 80% above the long-term norm,” Davis notes.

The bottom line: "[T]he trend is up and the Fed is friendly," Davis says. But the numbers are the numbers. "This is a real concern."'

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S&P 500 earnings on pace for 4th straight negative quarter

Traders at the New York Stock Exchange on Jan. 8. Photo: Wang Ying/Xinhua via Getty) (Xinhua/Wang Ying via Getty Images

Strong earnings reports from buzzy tech companies like Amazon and Microsoft have dominated headlines, but the numbers for the broader market remain negative.

What's happening: With 45% of S&P 500 having reported earnings, FactSet estimates an overall earnings decline of 0.3% for the quarter.

Banks may struggle to recreate 2019 success

Reproduced from Bloomberg; Chart: Axios Visuals

Wall Street analysts are betting the banks can't do it three years in a row.

What they're saying: Analysis from Yardeni Research shows the average expectation is for a 0.4% decline in S&P 500 diversified banks’ 2020 revenue and only a 3.8% increase in earnings.

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Stock market rallies despite coronavirus outbreak

Illustration: Aïda Amer/Axios

Little has changed about the fundamentals since last week's selloff that was the worst in months, but bullish stock traders have bid back all of the the S&P 500's losses and sent the Nasdaq to a new record high.

What's happening: The market continues to bet on generous central banks providing stimulus to help the global economy recover from the novel coronavirus outbreak that has stalled supply chains, closed businesses and quarantined millions of people.