INVESTORS BALANCE SHEET – PROS AND CONS
Here are a few of the pros and cons investors should consider when forming an opinion of the stock market. It is always important for investors to look at both sides of the argument even if they feel strongly in one direction, like we do:
PROS
The bull market remains intact. In fact, it still looks relatively young by historical standards. The S&P 500 is now up about 60% during this bull, but that is still not close to the average bull market gain of 114%. In terms of length, this one has lasted 725 days – roughly 300 days shorter than the bull market average.
Leadership rotation started in July. The leaderboard names are changing. The mega-caps have handed the baton to smaller peers. In the second half 97% of the S&P 500’s return has come from non-Mag 7 stocks.
Improving Economy. The economy has been humming along, better than previously thought. The September release of Q2 GDP showed a 3% annualized growth rate, and GDP data from the past five years was revised substantially higher. The Atlanta Fed’s GDPNow tracker for Q3 projects another 3% quarter.
Earnings Strength. Earnings estimates for the S&P 500 for the remainder of this year and 2025 are very strong. Wall Street analysts expect 9.8% growth in EPS for all of 2024 and 14.9% in 2025. One caveat: company executives don’t seem quite as confident as earnings guidance was mixed last quarter.
Easing Fed. The first rate cuts of the cycle have begun, but Treasury yields peaked a year ago. Lower yields are often seen as a positive for equities. At the corporate level, lower rates make financing more attractive while at the household level, lower rates spark mortgage refinancing demand and improve home affordability which frees up capital for equities. Caveat: the September CPI reading was higher than expected, pushing market rates higher. Another 50 bp cut seems to be off the table for the November Fed meeting. Most investors now expect a 25 bp cut but a case is being made for no cut at all. That could dampen investor enthusiasm for stocks in the short-term.
CONS
Here are a few of the bear arguments for stocks:
The S&P 500 now trades at 21.5x next year’s earnings estimates and the Magnificent 7 trade at 28 forward earnings. This is expensive. However, the equal-weighted S&P 500 is valued at less than 17x next year’s profit forecasts, less than both the five year and 10 year average P/E of 19. That is why investors need to look beyond the mega-caps of tech for long-term bargains.
In all fairness, there are other valuation measures currently flashing yellow or red. For example, Warren Buffet’s favorite valuation measure (the ratio of total market cap to U.S. GDP) is flashing red.
Recession on the horizon? Leading economic indicators are down significantly in the past six months, a rate of change observed previously in the context of recessions. Then there is the trusty old yield curve. The yield curve is now back to un-inverted (positively sloped) but recessionary periods have often started when the yield curve goes from inverted to un-inverted. We are watching these indicators closely.
The biggest hotspot is the Mideast. If Israel strikes Iran’s oil facilities and Iran strikes back at the gulf nations’ oil production, it is estimated that the price of oil could rise to $120/barrel according to Goldman Sachs (we are at about $75/barrel now). This would have a chilling effect on our inflation trend and overall economy.
Sentiment: Too Bullish. As a contrarian indicator, we never want to see investor sentiment get too bullish, and sentiment readings are currently very elevated. CNN’s Fear and Greed index is solidly in the Greed zone. And the 12-month average for AAII’s bull/bear sentiment readings is the most bullish in over 15 years, since just before the Financial Crisis!
Conclusion. As you can see, both the bulls and bears have good arguments. We side with the bulls because the reasons to stay bullish are more fundamental in nature: earnings, economy, and Fed easing. We expect the bull market to continue.