P/E - Lower P, Higher E

Macro Perspectives: Thu 10 Feb 22

Stocks continue to make a strong comeback.

Let's take a look at the technicals in the S&P 500. After all, I called this January decline a "technical" correction, so how do things look now?

As you can see in the chart above, we had a 12% correction in the S&P 500. We've since regained the 200-day moving average (purple line), and yesterday, we may have broken-out of the down trend (dashed black line).

This, as we are getting some fundamental fuel for stocks. Covid restrictions are easing in the more rigid states and areas of the world, signaling perhaps the release of more pent up demand.

Meanwhile, U.S. corporate earnings continue to defy the belief (of some) that Q4 would be a hiccup in the earnings streak. Positive surprises on earnings and revenues, are driving a better than expected earnings growth rate for the S&P 500 (with more than half of the constituents now reported for Q4).

We're on path to see nearly 30% earnings growth (yoy) - that would be four straight quarters of earnings growth above 25%.

Meanwhile, stock prices have come down to begin the year, which has reset the valuation on the broad market (lower "P", higher "E"), to a forward P/E of around 20. While that's above the long-term market average (about 16), it's not too expensive. Historically, when rates are low, the multiple on stocks tends to run north of 20 - even with the projected rate path, rates will be low for quite some time.

Importantly, within these Q4 earnings reports we are hearing "higher labor costs." We talked about this coming into earnings season as the expected theme of Q4.

But margins are solid - better than the year ago in comparison, and better than the five-year trend. Why? Because labor costs are being passed along to consumers through higher prices. And demand isn't waning.

So we've seen the reset in the price of assets (and stuff). Now we're seeing the reset in wages (though we should expect it to be uneven). This is the debt devaluation formula that was intentionally pursued by policymakers from the outset of the pandemic response - Inflate nominal prices (and therefore GDP) and pay back debt with less valuable dollars.