We are seeing the Dow and S&P 500 in record territory over the past week. Is there more room to run? It seems hard to make the case, especially given some of the economic stumbles over the last several months (such as the 0.1% Q1 GDP growth) and then the generally lack-luster earnings. For instance FactSet reported, “To date, 24 of the 30 companies in the DJIA have reported actual results. The blended earnings growth rate (combines actual results for companies that have reported and estimated results for companies yet to report) stands at -3.3%. If -3.3% is the final earning growth rate for the quarter, it will mark the third year-over-year decline in earnings in the past four quarters for the DJIA.”1 Time will tell if it was more than just “the weather,” but we are certainly skeptical that any sort of big economic upswing is on the horizon to drive valuations up further, as the signs continue to point to a lack of demand drivers. For instance, well past the weather issues, retail sales were only up 0.1% for April.
Furthermore there has been recent talk of overvaluations and even a stock “bubble.” For instance a recent article cited Shiller’s P/E ratio showing that valuations have only been this high in during the late 1920’s and prior to the 2007/2008 financial crisis.2 Does this very slow recovery that we are in the midst of, 5 years after the recession, justify well above average valuations?
While the headlines of record levels on the indexes make for a nice story, we actually haven’t seen the equity market do much over the first third of this year, even as we have seen a sizable decline in interest rates. One would think that the 40bps plus decline in rates on the 10-year Treasury would be supportive of an equity market rise, but the reality has been that the rate decline is on the back of weak economic data. Not to mention high energy and foods costs on the horizon that can impact consumer spending, to which about two-thirds of GDP is tied. Undoubtedly there will be some equity winners, depending on certain industries (for instance, we are favorable on certain subsectors of the energy industry), and we have seen M&A drive some moves of late, but broadly speaking, we feel that equities may have run their course.