Monday, April 5, 2021
Valuations aside, stocks are up because earnings are up
Stocks hit new record highs on Thursday with the S&P 500 (^GSPC) crossing 4,000 for the first time ever to close at 4,019.
Why are stocks up? It’s simple. Earnings are up.
While that might sound silly in its simplicity, it’s worth stating. Especially as market naysayers sound alarms about valuations as measured by price/earnings (P/E) multiples.
Sure, valuations are and have been elevated. But recent fluctuations in P/E multiples are nothing compared to the magnitude of the rebound in earnings. Credit Suisse’s top U.S. equity strategist Jonathan Golub puts a spotlight on this in his latest note to clients.
“Despite the damage inflicted by COVID, stock multiples rose from 18.2x at the start of last year to 21.8x today, well above long-term averages, and the highest level in over 50 years, excluding the Internet bubble period,” Golub wrote on Thursday.
“Since last June, 10-year Treasury yields have increased by 100 basis points (from 0.7% to 1.7%), leading many investors to question the sustainability of these elevated stock multiples,” he added. “Surprisingly, valuations have remained virtually unchanged over the past 9 months, as tighter credit spreads have largely offset rising treasury yields.” (Emphasis ours.)
With that set up, Golub shared this chart showing the progression of the S&P 500 index, S&P 500 forward earnings, and the S&P 500 forward P/E multiple.
We often see charts overlaying one or two of these metrics. But including all three proved insightful.
“As the exhibit [above] shows, with multiples stable, the market’s entire advance can be explained by improving earnings,” he said.
We’re not exactly breaking news here. Myles Udland wrote about this in December in his reflection on 2020. Pointing to a chart similar to the one above, Myles noted that stocks fell when earnings fell, and “the market’s bottom coincides with a turnaround in earnings expectations for 2021. A turnaround that has not yet leveled out.”