Stocks Rally On Tuesday
The S&P 500 was up 1.26% on Tuesday. The VIX was down 10.67% to 21.10 which is still relatively high. Every sector was up. The best ones were energy and healthcare which increased 2.14% and 1.52% respectively. Some traders have expressed hope that another sector such as the financials will take the leadership from the tech sector which has languished in the past few days. Tech was only up 1.01% which is surprisingly weak for a ‘risk on’ day. Some traders say they would rather see the market go up in small increments over time instead of a big spike up because spikes signal short covering. I’m not a short-term trader so I can’t specify which type of move I’d prefer.
PE Multiple Compression
My main focus is the understanding that double-digit earnings growth and a weak, but non-recessionary, economy aren’t consistent with a bear market. The chart below shows the 12 month forward PE ratio has fallen to 16.56 which is the lowest since early 2016. In 2016, I was bearish on stocks because they were increasing as earnings growth was negative. Now we’re seeing stocks fall on great earnings. Stocks like to price in future economic trends. In late 2016, it became clear the economy was starting to rebound. Now it looks like the economy is weakening. The key difference is firms have the benefit of tax cuts and a repatriation holiday. I don’t think it’s fair to completely ignore the great earnings results which is why I am confident in my projection that there won’t be a bear market.
1H 2018 Earnings Look Strong
The chart below shows the earnings estimate progressions for the past few quarters and the future ones. As you can see, the estimates last year generally fell before the reporting period and increased afterwards. This is the normal lowering of the bar so that the results can beat estimates. You can see the growth has been improving since Q4. This quarter hasn’t seen the normal decline in estimates. Obviously, the tax cuts provided a boost in January, but it’s still impressive that there haven’t been negative revisions. Q2 has also had steady estimates in the past few weeks. We’ll see how the results come in to determine how good this pre-earnings period was. If the results beat less than average, we’ll know the bar was raised too high. If they beat more than average, I think the market will have a swift exit from this correction and probably make new record highs.