Was Last Week the Turning Point?
April 24, 2018, 11:57 am
I believe last week will go down as an important turning point for investors who’ve felt trapped in the tug-of-war around trade policy, interest rates and the future of the mega-cap tech stocks that Wall Street bulls depend on to lead the charge. Despite the broader market finishing in the red today, the S&P 500 is still up 1.3% since last Friday’s close. More importantly, the market as a whole is back in positive territory for the year. Through months of elevated volatility and sometimes stunning 9%-12% downswings, investors have made money in the past 16 weeks. There’s still a lot of ground left to recover, but the floor now looks in place.
Earnings growth is the engine that drives the rising cycle through the distractions and occasional storms. Four months ago, the market was in the early stages of what turned into the brightest earnings season since 2011 and Wall Street was ramping up fast. Investors were willing to pay 18.4X 2018 EPS estimates because after years of relative stagnation the prospect of 18% growth was too good to pass up. Over the next few weeks, the S&P surged 8% from levels slightly below where the Dow trades now, only to watch external risk factors take that profit away. Long-term interest rates looked precarious, talk from Washington about trade tariffs prompted retaliation from China, Europe and other key economic partners and Facebook (FB) and Amazon (AMZN) got caught in the rumor mill. All of these crosscurrents brought the bulls to a grinding halt.
But at the end of the day, rumors come and go and numbers paint the real picture. The same stocks that investors bought at 18.4X earnings are now trading at a multiple of 16.4X, which is a substantial discount to what the market will tolerate as long as earnings are improving fast enough to bridge the gap in a reasonable amount of time. Between tax cuts and a strong economy, that growth curve signals that even the high multiples from the beginning of the year may actually be a little cheap compared to the amount of cash these companies will generate in the next six to 12 months. That means that either the bulls have a lot of room to run or stocks will get even cheaper quarter to quarter. Multiples are not going to get much lower before institutional investors come in to capture the discounts, leaving us with a bull run in the end after all.
Given this, I remain confident that the S&P will at least hit 3,000 by year-end and the Dow will close at 29,000 or 30,000. This isn’t based on wishful thinking. It’s just where a conservative reading of the numbers points us. The cycle is still in the early stages, with barely 10% of stocks on record with their performance for the trailing quarter. But as the results accumulate, I think Wall Street will be quite pleased.