Economic growth is meh, corporate profits are lackluster — and decelerating — and a trade deal is still uncertain. So why are do stock indexes rising as if they have lots more room to advance?
The reason is tepid earnings results throughout 2019, according to analysts at DataTrek in a Monday note.
“2019’s no-growth earnings will make for easy [comparables] in 2020 if the U.S.-China trade war abates,” DataTrek co-founder Nicholas Colas wrote.
To be sure, a down day for stocks on Monday because of another setback in trade talks is a reminder that his qualifier “if” is the operative word when thinking about a resolution on tariffs.
Colas said the final three months of 2019 should benefit from comparisons with last year, but Wall Street strategists now expect a 1.1% decline in earnings for the quarter.
Still, Colas does some back-of-the-envelope math to test his hypothesis. If investors believe one of the old chestnuts of investing wisdom, the “rule of 20,” they are expecting 17.5 times earnings. (The “rule” says that expected price-earnings ratios plus inflation, expressed by rates, totals 20. DataTrek assumes 2.5% on the 10-year U.S. note TMUBMUSD10Y, -0.76% to be “reasonable if global growth resumes,” and comes up with 17.5% for forward earnings.)
If the S&P 500 SPX, +0.27% is around 3,100, the 17.5 multiple implies earnings of $177 a share, an 8.6% premium over this year’s $163 a share. That is not bad for corporate results in a decade-old expansion. More to the point, Colas notes, “easy comps” can be an especially “powerful” narrative for investors.
“Valuations end up leading fundamentals, sometimes to absurd levels,” Colas said. “Unless U.S.-China trade talks hit a large pothole in coming weeks, that’s the narrative that should continue to drive US equity prices higher through the end of the year.”
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