CNBC’s Melissa Lee did one of the many CNBC “panel -of-experts” interviews in the last few weeks, (not on the Fast Money show, but during the day), and one of the experts she had on – one of three high-end, big-money-under-management, type individuals – talked about the S&&P 500 "earnings yield” and what it says about the market.
Probably more due to time constraints than a lack of understanding of the metric, Mel skated right over the interview, with the expert giving a 1-minute explanation of the metric and why this expert felt the metric was important. (This is not a criticism of Melissa Lee or CNBC – the network has so many experts on, on any given day, and the push to get the interview done in time and make it meaningful to listeners is formidable.)
This site has provided readers with the “S&P 500 earnings yield” metric every week since I started writing about it , (and more so once I started detailing the weekly Thomson Reuters I/B/E/S data) and my guess is many readers probably do not recognize its importance or what it is saying about the stock market.
Personally, the “earnings yield” started to gain gravitas with Alan Greenspan’s “irrational exuberance” comment all the way back in 1997. While at the time some thought Fed Chair Greenspan was actually talking about Japan, he also noted the “Fed Model” in either the same or a similar speech around that time, which model incorporates the S&P 500 earnings yield as one of its components.
The Fed Model in its simplest form says that when the S&P 500 earnings yield and the 10-year Treasury are roughly the same yield, the S&P 500 valuation is thought to be in equilibrium.
Obviously, today the S&P 500 earnings yield (as of last Friday, 11/17/17) is 5.50% and the 10-year Treasury is yielding 2.32%, which is likely telling us that the S&P 500 continues to be reasonably undervalued, while the 10-year Treasury is – well – overvalued, at least relative to each other.
There sure seems to be more risk in interest rates and Treasuries than in stocks today, but that has been the case for a while.
Looking at the year 2000, for comparison purposes, the S&P 500 eventually printed a high tick in March, 2000, of 1,550 and the full-year 2000 actual S&P 500 earnings of roughly $55, so the S&P 500 earnings yield at the March, 2000 peak was roughly 3% – 3.5%. The P.E ratio on the NASDAQ in the late 1990’s was 80(x) – 100(x) the NASDAQ’s expected earnings.
Jeff Miller, who owns NewArc Capital in Naperville, Illinois and writes his own blog “Weighing the Week Ahead” and has a PhD in Economics, has discussed with me the S&P 500 earnings yield and how for Jeff, that metric is a proxy for the ERP or the Equity Risk Premium. (Jeff is as solid an investment thinker and as good a writer as anyone on Wall Street, and I listen to him.)
Others who will talk about the S&P 500 earnings yield are David Kelly, the global equity strategist over at JP Morgan. David and his staff came through Chicago and invited guests to a morning presentation in July, 2012, and the S&P 500 earnings yield at that time was roughly 8% (!) and Dr. Kelly mentioned the S&P 500 earnings yield in his opening presentation. (The S&P 500 at the time was trading around 1,300 – 1,350.)
Finally, even Doug Kass, the popular blogger over at TheStreet and a noted Wall Street bear, will toss out the S&P 500 earnings yield on occasion, but not too frequently since it has been telling a bullish story for the last 10 years.
So what’s the point of this discussion ?
David Templeton, CFA, of Horan Capital Advisors out of Cincinnati, sent me a Ned Davis research report earlier this week, where Ned Davis notes that “global equities have been reaching record highs while at the same time P/E ratio’s have reached new lows.”
This research piece, referencing the “earnings yield” for various global markets, seemed a little cautious, as everyone has been during this bull market. The segment was titled, “Beware of Shifting Earnings Sentiment” noted that the “E” (earnings) has risen faster than P (price) referencing global equity markets.
The P/E ratio sees more daily abuse than a rented mule and thus, with the downtime of Thanksgiving. and some time to reflect for readers, I wanted to bring the S&P 500 earnings yield to readers attention and say “don’t ignore it” in the grand scheme of market valuation metrics. The S&P 500 earnings yield is NOT a timing tool in the broad scheme of the stock market, nor is the weekly earnings posts, but it is like the changing weather in the spring and the fall – it can give you an idea of what’s to come.
Conclusion: While the caution and prudence of the Ned Davis note is warranted, meaningful tax reform with cash repatriation, could push “E” even higher in late 2017, early 2018. That being said, and if and when tax reform happens, and IF cash repatriation is a meaningful part of reform (and, given Congress, that could be a big if) the S&P 500 earnings estimate could benefit to the tune of $5, $6, $8 and even $12 per share, and these are all estimates heard from various Wall Street sources. My own unsophisticated guess is that repatriation will be at the lower end of those EPS estimates. it will likely be at that point the S&P 500 treads water, but given the 5.5% S&P 500 earnings yield, the 18(x) P.E ratio, expected “organic” earnings growth of 10%, and the complete lack of any “fever” for the US stock market, my response to client questions about a an equity bear market is that “yes, we will see corrections, but it is highly improbable we will see anything like the two bear markets from 2001 – 2002, and the 2008 – 2009.”
The S&P 500 earnings yield – in my opinion – continues to indicate that the S&P 500 is reasonably valued.
Retail investor sentiment alone would keep me invested today – so many people i talk to have to be walked off the ledge, after the two bear markets of the decade from 2000 through 2009.
The 1982 to 2000 US stock bull market had one year with a negative S&P 500 return, and that was 1990, where the S&P 500 fell 3%, after Saddam Hussein rolled into Kuwait in August, 1990.
My own opinion is the next real shock could / would come from the US bond markets, i.e. Treasury, interest rates, credit spreads, etc.