The S&P 500 is down over 5.5% in the past three days, and down nearly 10% since the beginning of September. The market decline has been driven by a 12% reset (3.0x multiple reduction) in S&P 500 P/E multiples as rising COVID cases, a lack of government stimulus, and implications of the upcoming presidential election weigh on growth outlooks. However, during the same period S&P 500 earnings estimates have risen nearly 4%.
Recent market performance and the stark contrast between investor growth expectations and earnings estimate revisions highlights three market dynamics occurring:
- Investors are exhibiting knee-jerk reactions to the rising COVID cases, which is being amplified by the upcoming US Presidential election
- Earnings estimate revisions tend to lag expectations and there is still a “backlog” of sell-side estimate revisions from March that are trickling into the market, and
- Economic growth expectations may be facing a potential wave of “earnings resets” as the recovery from COVID is drawn-out.
Multiple expansion has driven the rally since March
To understand the current market dynamics better it helps to go back to March 23 when the S&P 500 bottomed.
Since the market bottomed on March 23 earnings estimates have actually fallen by over 8% while forward earnings multiples on the S&P 500 have increased by over 46%. This is because (as the chart above shows) earnings estimates didn’t actually bottom until June.
This dynamic of lagging estimate revisions and investor growth optimism has led to a market rally heavily skewed by multiple expansion. In fact, earnings estimates have been playing catch-up since the recovery started.
However, this dynamic has started to change recently. Since the market sell-off in September multiples have contracted amid investor de-risking over the pace of COVID-recovery and the implications of the upcoming US Presidential election. At the same, earnings estimates revisions have continued to trend higher as analysts play catch-up to (slowly) recovering businesses .
Looking ahead – a recovery is still on the horizon
Looking ahead we maintain our view that market volatility is likely to be elevated near-term, and that regardless of a “Blue Wave”, Trump win, or Biden win, markets are more likely to be higher a year from now than they are today. We think selective risk exposure remains appropriate, especially when it comes to allocating capital into equity markets.
Given the heightened volatility and increased dispersion across sectors, we think tactical tilts inside a portfolio are appropriate as not all industries and companies will recovery equally post-COVID. We suggest investors work with their Advisors to determine the most appropriate action for their investments.
Day to day market dynamics are noisy and difficult to truly understand. We prefer to take a longer-term, thematic view when analyzing markets and investments. In that regard, we do not expect the events of the past few weeks to have a material impact our long-term view on markets. The COVID-19 recovery was always expected to be drawn-out, with an initial surge in activity likely to level out and then gradually improve.
ENDNOTES
Disclosures
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.