The Devilish Details of the S&P

These past few weeks we have come across very few trends—macroeconomic, capital market, geopolitical or otherwise—that warrant the sort of optimism for the New Year that would substantiate present valuations across a range of equity markets. Keeping our editorial light for the month, we selected a few top-of-mind views to support our continued cautious stance on domestic equity market exposures.

In Figure 1, we show that the trends in year-over-year declines in both revenue and earnings per share have not reversed since we last offered these data earlier in the year. The Energy sector, buffeted by plunges in petroleum and petroleum product prices, is not the only culprit. In Figure 2, we show year-on-year earnings growth across all ten sectors. With a few exceptions, earnings per share growth is slowing or is in outright decline.

Indeed, profits are feeling the squeeze. Charted in Figure 3, this trend should not be so surprising, really, considering the long duration of weak to declining top-line growth. American managers seem to have run out of room to pare costs. As top-line growth slows, even turning negative, competition for incremental dollars intensifies. Profits suffer more. This down-cycle might turn, but we think it’d need resurgence in revenue growth to do so. Broader macroeconomic reviews limit optimism of any such turn in the medium term.


Nonetheless, even with the late summer correction, the S&P 500 has held up pretty well this year. That only can mean domestic large-cap equities are now even more expensive, decreasing the likelihood of further gains and increasing their inherent risk. Figure 4 reprises a chart we have shared in earlier commentaries that shows the near-term average price-to-earnings ratio for large-cap U.S. stocks relative to their long-term average. Elevated and still rising, the ratio can normalize only two ways: via a dramatic ramp in earnings, or as dramatic a decline in price. Leading macroeconomic indicators would suggest the path from here is heavily weighted to the latter.