S&P 500, the U.S. stock market index, closed at an all-time high on hopes for a potential treatment for the coronavirus outbreak, which has resulted in more than 25,000 identified cases
The stock market index, S&P 500, closed at an all-time high on Wednesday on hopes for a potential treatment for the coronavirus outbreak, which has resulted in more than 25,000 identified cases. However, this market resurgence might be short-lived.
The stock market index rose 1.1% to close at a fresh record on Wednesday, while the Dow Jones Industrial Average jumped 1.7%.
Partly because of this treatment breakthrough, the S&P 500 has returned to trading at 19 times the expected 2020 earnings of $174 a share, Tom Essaye, founder of Sevens Report Research, wrote in a note on Wednesday. As an additional bolster, the People’s Bank of China has been flooding money into the financial system over the last several days to stabilize the market.
Essaye says the market’s current valuations are inflated because they don’t take into account the fact that fourth-quarter earnings reports didn’t increase expected earnings, and the current quarter’s earnings will be negatively affected by the virus.
Point being, this market is once again 4 to 6% ‘overvalued’ and, as such, we’re susceptible to another 4 to 5% pullback like we just experienced over the past two weeks, Essaye stated.
Essaye thinks the appropriate S&P 500 multiple should actually be 18 times expected 2020 earnings because of the impact of the coronavirus on growth and earnings.
Many stars would have to align for the current 19 times price-to-earnings multiple to be realistic, Essaye believes. Those include continued market interventions from the Federal Reserve, U.S. negotiations with China over a phase-two trade deal or tariff reductions, coronavirus containment, global economic growth recovering from the virus, and expected 2020 earnings for S&P 500 companies hitting $180 per share.
The combination of these actions could move the S&P 500 to a “best-case scenario” up to 3400 to 3500, Essaye wrote.
To be clear, I hope all that happens, but that’s a lot of ‘ifs’ that need to occur for a 5% return, Essaye said.
Stocks are currently “priced for perfection,” Essaye warns, which makes them even more vulnerable to problems. He says the coronavirus repercussions aren’t over, making short-term investments with new capital “still unattractive.”
Large losses could be ahead if the Fed doesn’t maintain low interest rates or if the global economy turns downward, for instance. Essaye estimates each factor would lower the S&P 500 earnings multiple by a full point, making the suitable multiple 16 times expected 2020 earnings.
Based on that multiple, about a 5% reduction in annual earnings would put the S&P 500 at 2720, an 18% reduction from current levels. Essaye warns that a hawkish Fed and a stagnation of global growth would lead to other problems, meaning a 15 times multiple “wouldn’t be out of the question.”
One key indicator, however, could ease market fears of a larger recession. If the 10-year Treasury yield can return to pre-coronavirus rates of 1.80%, Essaye says this would serve as an “important ‘all clear’ on future growth.”
