Stocks May Have Hit A Ceiling

The stock market averages had a great April with the Dow, S&P 500 and NASDAQ up 11.1%, 12.7% and 15.5%, respectively, And even though all the indexes were down over 2.5% on Friday they have all risen at least 25% from their lows of March 23 with the Dow being the strongest, up 28%. The challenge will be adding to these gains as earnings estimates continue to fall against very high valuations.

S&P 500 as expensive as late 2001

Estimates for the S&P 500 companies earnings have fallen by 25% since the beginning of the year per John Butter, Senior Earnings Analyst, at FactSet. His weekly “Earnings Insight” shows that the Index is now trading slightly above a 21x PE multiple on 2020’s profits with late 2001 being the last time this occurred. And even on 2021’s forecast the S&P 500 has a PE of almost 17x.

Bear trap or truly sustainable?

Given what has occurred in the economy with over 30 million people filing for unemployment insurance in just six weeks; economic reports showing huge drops in retail sales and industrial production; to an explosion of the federal deficit it is not surprising the S&P 500 fell 35%. What is interesting, to a large degree, is that it has rebounded by 27% and is now only 555 points or 16% below its all-time high.

This is largely due to the Federal government pumping trillions of dollars into the economy, the Federal Reserve also throwing trillions of dollars to stabilize the fixed income markets and incremental better news in the fight against the coronavirus. While the stock market tends to be forward looking, the financial outlook is biased to earnings estimates continuing to fall, which will increase already multi-year record high valuation multiples.

Estimates are almost guaranteed to decrease

The first estimate for March quarter’s GDP came in at a negative 4.8%. This was the worst showing since the December 2008 quarter when the economy shrank 8.4%.

Unfortunately, the economy is forecast to have a much worse outcome in the June quarter. While only one month has elapsed in it, estimates range from at least a mid-teens drop to downwards of 40%.

Keep in mind that these are annualized numbers. The U.S. Bureau of Economic Analysis, or BEA, does a quarter-to-quarter comparison and then multiplies by 4 to get a yearly result. While down 10% to get to a 40% number is definitely not in any way “good”, it should be kept in mind when hearing about a negative 40% projection.

S&P 500 earnings estimates took another hit this week

At the beginning of 2020 Butters was estimating that the S&P 500 companies would earn $177.77. With the S&P 500 valued at 3,231 its PE multiple was 18.2x. Below is how the estimate for this year’s S&P 500 earnings has decreased, with the first meaningful decline occurring during the week of March 20.

• JANUARY 3: $177.77
• JANUARY 10: $177.64
• ——
• FEBRUARY 21: $175.98
• FEBRUARY 28: $175.74
• MARCH 6: $174.92
• MARCH 13: $173.55
• MARCH 20: $169.86 (first meaningful decline in 2020 estimate)
• MARCH 27: $164.59
• APRIL 3: $159.76
• APRIL 10: $152.81
• APRIL 17: $143.61  
• APRIL 24: $137.98
• MAY 1: $133.83 (decrease of 25% from January 10). PE multiple of 21.2x

Note that the S&P 500’s PE multiple has increased from 18.2x at the beginning of the year to 21.2x currently.

2021 S&P earnings estimates

The first time Butters published an estimate for next year’s S&P 500’s earnings was on January 10. He was forecasting earnings of $196.57, which translated to a PE multiple of 16.4x. Below is how 2021’s earnings estimate has changed since then.

• JANUARY 10  $196.57  (1^ST time published in FactSet’s weekly “Earnings Insight”)
• ——
• FEBRUARY 21: $195.88
• FEBRUARY 28: $195.77
• MARCH 6: $195.16
• MARCH 13: $194.06
• MARCH 20: $190.62 (first meaningful decline in 2021 estimate)
• MARCH 27: $187.08
• APRIL 3: $183.04
• APRIL 10: $178.03
• APRIL 17: $173.62
• APRIL 24: $170.36
• MAY 1: $168.29 (decrease of 14% from January 10). PE multiple of 16.8x

While it is possible the S&P 500’s earnings could rebound and start to move higher, history and what is occurring in the economy makes this unlikely. As shown in the chart above earnings estimates tend to decrease over time and we are only in May 2020 with more than a year to go for 2021 to play out. Earnings only need to decrease another $5 to essentially match 2018’s and $7 to reach 2017’s level. Both of those amounts were eclipsed during April when 2021’s projection fell by almost $15.