{"id":9160,"date":"2019-07-06T14:01:43","date_gmt":"2019-07-06T14:01:43","guid":{"rendered":"https:\/\/fundamentalis.com\/?p=9160"},"modified":"2019-07-14T23:02:11","modified_gmt":"2019-07-14T23:02:11","slug":"on-sp-500-valuation-pe-expansion-compression-and-the-financial-sector","status":"publish","type":"post","link":"https:\/\/fundamentalis.com\/?p=9160","title":{"rendered":"On SP 500 Valuation, PE expansion \/ compression, and the Financial Sector"},"content":{"rendered":"

Dr. David Kelly and his team at JP Morgan put together – each quarter – one of the best capital market, economic and portfolio management summaries on the Street in the form of JP Morgan’s, “Guide to the Market”.<\/p>\n

This valuation table is typically found in the first 10 pages of “The Guide”. Here is a spreadsheet summary of the last few years of the SP 500 Valuation Table:<\/p>\n

\"\"<\/a>
click to enhance \/ enlarge<\/figcaption><\/figure>\n

Here is the actual chart from the June 30, 2019, Guide:<\/p>\n

\"\"<\/a>
click to enhance \/ enlarge<\/figcaption><\/figure>\n

 <\/p>\n

Looking at the far-right column of the valuation metrics, readers can see – either on the Excel spreadsheet or on the chart itself, that – as measured by standard deviation – the valuation measures are within the normal valuation ranges.<\/p>\n

As a cash-flow guy, here is a blog post<\/a> from May ’15, when the SP 500’s price-to-cash-flow valuation had just moved over 10x cash-flow. At 12x cash flow today the SP 500 is getting a little more salty, but hardly near 1987 levels or early 2000 levels of 27x – 28x PE.<\/p>\n

Note too on the spreadsheet how valuation measures have compressed – that is a function of the flat SP 500 we’ve seen since late January, 2018.<\/p>\n

Speaking of PE compression:\u00a0<\/strong><\/em><\/p>\n

\"\"<\/a>
click to enhance \/ enlarge<\/figcaption><\/figure>\n

 <\/p>\n

This table and charts are from John Spencer, Director of Wealth Management of Hackman Financial in Cincinnati, Ohio. John and i went to school together in Cincinnati, and we typically chat about the markets when we have time to do so.<\/p>\n

The top chart – yellow and blue lines show – show plainly that there has been little “PE expansion” in this bull market, since March, 2009.<\/p>\n

To highlight John’s work, I took a look at SP 500 cumulative earnings growth from 1990 to 1999, versus the cumulative return on the SP 500 and SP earnings grew 79% cumulatively for the decade, while the total return on the SP 500 for the same period was 190%.<\/p>\n

The point for readers is that there has been little to no PE expansion in this 10-year bull market despite the cacophony of the SP 500 being overvalued.<\/p>\n

PE expansion is typically the hallmark of bull markets.<\/p>\n

Gives the reader some idea of how this market remains so hated, even as it breaks out to an all-time-high.<\/p>\n

Market cap vs Earnings weight – is the Financial sector a screaming buy ?<\/strong><\/em><\/p>\n

\"\"<\/a>
click to enhance \/ enlarge<\/figcaption><\/figure>\n

 <\/p>\n

Seeking Alpha has always been kind of enough to pick up the posts on this blog, and this recent post<\/a> on Financials and the pretty substantial disparity between Financials earnings weight in the SP 500 and the sector’s market cap weight, elicited very few thoughtful responses.<\/p>\n

You’d think – maybe as one investment strategy – that readers would overweight the sectors where the market cap was less than the earnings weight and underweight the opposite – but I have no historical data on how that strategy would have performed.<\/p>\n

My own opinion is this “gap” is way too big, but also, I don’t know what breaks the Financial’s out of their malaise.<\/p>\n

Maybe higher long-end rates, maybe a steeper yield curve (same thing), maybe faster economic growth, and maybe some combination of all three.<\/p>\n

Q2 ’19 earnings should be interesting for the sector. Of the 11 sectors within the SP 500, Financial’s are actually expecting the strongest earnings growth for calendar 2019:<\/p>\n