Even without a reverse shift, the economy is slowing.
“As we enter the second half of the year, the biggest gains are disappearing in the rearview mirror,” Stephanie Pomboy writes in her latest MacroMaven’s message. Now the ‘familiar ‘forward-looking’ stock market will face what it calls the ‘F’ word – the fundamentals – of slowing earnings growth in the coming quarters.
So far, equities have followed the earnings outlook for the current year. But as the focus shifts to 2022, they will face high stock prices and slowing earnings. That could be “especially problematic with valuations dangling on nosebleeds,” Pomboy writes.
Inflation adds to the valuation problems. The “rule of 20” states that the sum of inflation and the stock market’s P/E ratio should be 20, writes Doug Ramsey, chief investment officer at the sLeuthold Group. Why? Empirically, that was the median P/E for the
index, based on generally accepted accounting trailing peak earnings, or GAAP, dating back to 1957. Since 1995, the median P/E on that basis is 10% higher.
Based on the recent reading of the consumer price index, the rule of 20 calls for a P/E of 14.6 times – a “number that probably sounds ridiculously low to almost all stock investors.” In reality, the S&P is trading at more than double that multiple, based on trailing GAAP earnings, a level last seen at the height of the dot-com “new era” of the late 1990s.
Read more up and down Wall Street:Disco Inferno: The US Could Go Back To 1970s-Style Stagflation
The final episode was followed by a “catastrophe for large-cap stock investors,” Ramsey said. If there’s even a slight convergence between the current P/E ratio and what the rule of 20 indicates, owners of S&P 500 funds and those mimicking the index will “have a hard time again,” he adds.
And he concludes: “If investors are only looking to achieve a meager total return of 4% to 6% in the coming years, company fundamentals and average valuations must outperform their favorable new period. Believing that the ‘glass is half full’ is no longer enough.”
Write to Randall W. Forsyth at email@example.com