from the October investment comments of Provident Investment Management
From listening to the media, it is hard to believe the market is again flirting with all-time highs. An “inverted” yield curve, trade policy uncertainties, overseas economic weakness and always-present political instabilities, such as the recent attack on Saudi Arabian oilfields, should surely be enough to make anyone run for cover.
But these concerns don’t seem to be holding back equity investors. The forward-12-month P/E ratio for the S&P 500 is 16.8, just slightly ahead of the five-year average of 16.5 and about 14% above the 10-year average of 14.8, a period that includes very weak earnings from 2009 and 2010. Further, unlike a year ago, analysts aren’t expecting double-digit earnings growth. For calendar years 2019 and 2020, earnings are expected to grow 4.3% and 5.6%, respectively.
Given the media’s “wall of worry,” can these modest earnings projections hold up? The answer likely lies with the U.S. consumer, who for now is doing quite well. Jobs and income growth continue to move in the right direction. August job growth was 130,000, a bit inflated by the hiring of temporary workers to support the U.S. Census. The unemployment rate stayed at 3.7%. Average hourly earnings were up 3.2% over the past year and 4.0% when including the boost from additional hours worked. With inflation running around 1.5%- 2.0%, consumers are enjoying solid real income gains they can spend to support the economy. This strength is showing up in retail sales, which grew 0.6% month-over-month in July on top of a 0.7% increase in June.…
… As is always the case, stock selection is very important but particularly so in this economic environment. According to FactSet, companies in the S&P 500 that rely more heavily on foreign sales are expected to see earnings lag. For firms with less than 50% of sales from overseas, third quarter earnings are expected to grow 0.4%. This isn’t anything to write home about, but it is far better than the 10.7% decline expected for firms with more than half of sales generated overseas. The combination of weak overseas economies and the strong dollar are hurting these companies far more than their more U.S. dependent brethren.
In summary, while the market looks modestly expensive, expectations are reasonable and there is the possibility that if trade tensions ease economic performance can improve, providing the setting for further market gains.