Even without going into reverse, the economy is slowing down.
“As we move into the second half of the year, the biggest gains roll back in the rearview mirror,” writes Stephanie Pomboy in her latest MacroMavens Missive. Now, the “known“ future ”stock market will have to contend with what it calls the“ F ”word – fundamentals – of slowing earnings growth over the next few quarters.
So far, stocks have tracked the current year’s earnings outlook on the upside. But as attention shifts to 2022, they will face high stock prices and slowing profit gains. This could be “particularly problematic with suspended assessments of nosebleed levels,” Pomboy writes.
Inflation adds to valuation problems. The “rule of 20” assumes that the sum of inflation and the stock market’s price-to-earnings ratio should add up to 20, writes Doug Ramsey, chief investment officer at sLeuthold Group. Why? Empirically, this has been the median P / E for the
index, based on generally accepted accounting principles sliding peak revenues, or GAAP, dating back to 1957. Since 1995, the median P / E on this basis has been 10% higher.
Based on the recent Consumer Price Index reading, the Rule of 20 predicts a P / E of 14.6 times, a “number that probably looks ridiculously low to almost any equity investor.” In fact, the S&P is trading at more than double that multiple, based on GAAP earnings, a level last seen at the peak of the “new era” dot-com of the late 1990s.
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This latest episode was followed by a “catastrophe for large-cap equity investors,” according to Ramsey. If there is even a minor convergence between the current market P / E and what the Rule of 20 says, owners of S&P 500 funds and those who mimic the index “will again have to bad to live, ”he adds.
And he concludes: “For investors to achieve a meager 4% to 6% total return over the next few years, company fundamentals and mid-valuations will have to outperform during the favorable period of the new era. Believing that the “glass is half full” is no longer enough.
Write to Randall W. Forsyth at [email protected]