The stock market is entering a new phase: Earnings are up and multiples are down

#stockmarket #MorningBrief #YahooFinance Myles Udland, Julie Hyman, and Brian Sozzi break down the outlook on earnings growth for the market amend economic recovery. The stock market is entering a new phase Investors right now are faced with a simple question:…

The stock market is entering a new phase: Earnings are up and multiples are down

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#stockmarket #MorningBrief #YahooFinance
Myles Udland, Julie Hyman, and Brian Sozzi break down the outlook on earnings growth for the market amend economic recovery.

The stock market is entering a new phase
Investors right now are faced with a simple question: how much?

How much do they want to pay for earnings growth that continues to blow away expectations but might also be peaking.

Back in early April, my Morning Brief collaborator Sam Ro highlighted the most important chart for understanding the market rally.

The chart, which came from Credit Suisse equity strategist Jonathan Golub, showed that while stock prices had been in rally mode for months, the market wasn’t getting more expensive.

And now, investors think the market might actually start getting cheaper.
Over the weekend, strategists at UBS, Morgan Stanley, and Goldman Sachs all published notes that argued valuations were likely to be flat or down in the coming months as growth slows, expenses rise, and fears over higher taxes weigh on sentiment.

Right now, the S&P 500 currently trades at roughly 22x forward earnings. You might hear this referred to as the market’s multiple or its valuation. The terms are roughly interchangeable. And we say roughly because there are always exceptions.

So a simple way of thinking about the earnings multiple for the market is how much you need to pay as an investor for $1 of earnings power. On Monday, the S&P 500 was trading at around 4,150. According to the latest data from FactSet, current earnings estimates for the S&P 500 are around $187. Divide the level of the index by the expected annual earnings for the index and you get the earnings multiple. In this case, 4,150 divided by 187 is 22.2. So for every $22.20 you put into the S&P 500, you can expect to get back $1 in earnings based on today’s estimates.

In the beginning of the current rally, the market’s earnings multiple expanded from around 18 to 22 as investors responded to lower rates and anticipated that earnings growth would be revised higher. For the last year or so, the multiple has been flat as earnings are revised higher as had been anticipated. And now, strategists think the multiple is likely to fall as we enter a new phase of the recovery.

Mid-cycle is here, and with it comes a transition from early cycle leadership,” writes Morgan Stanley equity strategist Mike Wilson in a note published Monday. “The missing piece, so far, for the mid-cycle transition — lower valuations.”

But Wilson thinks these are coming.

As bull markets transition from early-cycle recovery phases to slower growth mid-cycle periods, Wilson notes that valuations typically decline 10%-20%. A decline of this magnitude against today’s valuation backdrop could see the S&P 500’s earnings multiple fall to as low as 17x forward earnings.

“Risk premium compresses with excitement around recovery, but eventually higher rates, positioning resets, and a slowing rate of change in growth offset this and send multiples lower,” Wilson writes. “Earnings growth in a strong economy mitigates downside, but rising costs and higher corporate taxes now limit the upside. The net effect is a tug-of-war between earnings/valuation, tepid returns over the next 12 months, and a likely 10-20% correction between here and there.” Wilson has a base case S&P 500 target of 4,225 by June 2022.

Keith Parker and the equity strategy team at UBS also cautioned investors that multiples are likely to compress this year in a note published Monday. But the strength of earnings growth is likely to overwhelm this dynamic, with UBS raising its year-end S&P 500 price target to 4,400 today from 4,250.

For more on this article please visit:
https://finance.yahoo.com/news/earnings-up-multiples-down-morning-brief-100154568.html

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