Stocks met a significant milestone this week as the S&P 500 retraced over half of the losses sustained in the coronavirus sell-off. As I write, the S&P 500 is set to open up about 3%, bringing the retracement to about 55%. The rally in stocks has been nothing short of incredible. The index is up about 28% since the low (March 23) in just a little over 3 weeks! What makes this all the more interesting is that earnings estimates continue to plummet. Since the aforementioned market low on March 23, the consensus estimate for S&P 500 earnings over the next twelve months is down another 11% to about $150. We show the trend in the first chart below.
But even as estimates continue to decline (and, frankly, nobody currently knows where the bottom will be), investors are willing to pay higher and higher prices per dollar of earnings. The next chart below shows that the S&P 500 index and the index’s price-to-earnings (P/E) ratio on next twelve-months’ earnings had moved pretty much in lock step until the beginning of April. However, since the beginning of April, the P/E ratio has spiked in much more dramatic fashion compared to the index itself. In fact, the P/E ratio has risen 4 multiple points to 19.1x – its highest level since April of 2002!
We are well aware that a massive amount of fiscal and monetary stimulus has been unleashed to fight the effects of the coronavirus. We are also well aware that the market typically reflects conditions six months or more in the future. If so, investors are simply saying the economy will be in a much better place by the end of this year. A better economy will beget a better outlook for corporate earnings, and we can all rejoice. Still, I’m struck by rather sudden wave of optimism about the coronavirus and its economic implications. It seems that almost everyone is now convinced that not only will we bring the spread of the disease under control in the fairly near future, but also that we’ve seen the market lows. Just 1-2 weeks ago nearly everyone thought we would retest the lows of March 23! Is it possible to have such conviction about something that seems so unknowable?
I’m also struck by the continued narrow leadership in the market. The FAANG stocks seem to rise much more in strong markets while falling much less in weak markets. As a result, the Technology and Communication Services sectors continue to grow in importance within the S&P 500 (their combined weighting has risen to 36.5%). Meanwhile, the sector darlings of yesteryear, the Financial and Energy stocks, feel tied to the whipping post. It sure seems like taking some FAANG gains and allocating to those gains to sectors that have dramatically underperformed could make some sense sometime soon. For our part, we continue to find most value in companies with the financial resources to endure whatever may come.