from the October investment comments from Provident Investment
Against a backdrop of tariffs, Federal Reserve interest rate increases, and emerging-market struggles, the S&P 500 steadily advanced to a new all-time record in late August. This has now become the longest bull market in history, measuring 9-1⁄2 years from the low of March 9, 2009.
Common sense would dictate that what goes up must come down. However, in the long term the market’s value is a function of corporate earnings growth, and that has been stellar. According to FactSet Research, second-quarter S&P 500 earnings growth was 25%, supported by a 10.1% sales advance. Analysts expect third-quarter earnings to grow 20% and full calendar year 2018 growth of 20.6%. A one-time event, corporate tax reform, has accounted for about half of the earnings increase, but accelerating sales supported by a strong U.S. economy is an ongoing market driver.
Market valuations look stretched on a historical basis, but the market’s value is not solely a function of history. On a trailing-12-month P/E basis, the S&P 500’s multiple is around 21, about 11% and 24% higher than the past 5-year and 10-year averages, respectively. This P/E only captures half the benefit of tax reform. Moreover, analysts expect continued growth for calendar year 2019, with earnings and sales expected to increase approximately 10% and 5%, respectively. On a forward-12-month basis, the S&P 500 P/E ratio of 16.7 is only 2% higher than the five-year average (16.3) and 16% higher than the 10-year average (14.4). Earlier in 2018, stocks looked much pricier as the forward-12-month P/E was about 18.5.…
At the end of 2016, the market looked overvalued. The forward-12-month P/E was over 16, about the same level as today. Since then, the S&P 500 has advanced about 34%, a performance no one expected. This reinforces the philosophy of buying well-run growth companies at acceptable prices, regardless of market environment.