Evaluation: Costly US inventory valuations weigh on earnings to proceed rally

© Reuters.

By Lewis Krauskopf

NEW YORK (Reuters) – US corporate results and earnings outlook are becoming increasingly important to maintain investor optimism on a stock market rally that has driven valuations near a 20-year high.

According to Refinitiv Datastream, the benchmark will be trading at 22.6x earnings estimates for the next 12 months. This price-earnings ratio (P / E) – a common measure for valuing stocks – is well above the long-term average of 15.3 and has risen since the market bottomed in March.

Investor rationale for the historically high valuations was based on expectations of a spike in growth as the economy emerges from COVID-19 shutdowns, massive fiscal and monetary support, and the relative attractiveness of stocks to bonds.

With the S&P 500 up about 70% from its March lows, earnings season could be an important test of whether the rally preceded fundamentals. This is a major concern of investors who believe that unprecedented budget and monetary spending has resulted in excessive risk taking.

"Return expectations for stocks are heavily dependent on the recovery in earnings in 2021," said Chris Haverland, global asset allocation strategist at Wells Fargo (NYSE 🙂 Investment Institute.

According to Friday's Refinitiv data, S&P 500 company earnings are expected to rise 24% in 2021, after falling 15% in 2020. Reports that could shed some light on the outlook for 2021 will kick in more strongly this week.

So far, the results have been stellar: Of the 26 S&P 500 companies that reported last week, 88% exceeded earnings estimates for the fourth quarter, considered "one of the strongest in history," BofA Global Research said in a Note on Tuesday.

Was among the recently reported Goldman Sachs Group Inc (NYSE :), which posted a blockbuster fourth quarter profit on Tuesday. However, Goldman executives cautioned that capital market activity that has been producing results recently is likely to slow down.

Haverland draws parallels between the current market and the outbreak of the financial crisis a decade ago. Much like in 2020, growing valuations helped boost the stock market in 2009 as investors anticipated an economic recovery, Haverland said.

"In 2010 you saw earnings growth catch up there … and we believe it will develop in a similar manner in 2021," said Haverland.

Investors also hope that the earnings season will help them determine how justified stock valuations are. The equity risk premium, which compares the income return on stocks to the return on 10-year US Treasuries, is currently favoring stocks, according to Keith Lerner, chief market strategist at Truist Advisory Services. The S&P 500 exceeded the one-year yield on the 10-year Treasury note by an average of 10.3% when the risk premium level was at the end of 2020, he said.

"The absolute ratings are historically extremely high," said Lerner. "But everything else too, and you still have to look for relative investment opportunities."

Many are also closely watching the size and timing of the tax aid under President-Elect Joe Biden, which is expected to be a key factor in determining investor risk appetite in the months ahead.

In her Senate affirmation hearing on Tuesday, Treasury Department candidate Janet Yellen urged lawmakers to "go big" on the next coronavirus bailout after Biden submitted a $ 1.9 trillion stimulus proposal last week Part of a domestic political agenda with high government spending.

Supportive fiscal and monetary policies "put a word to the market" that signals policymakers to "do whatever it takes to get both the market and the economy from that point to the other," said Liz Young, director for Market Strategy at BNY Mellon (NYSE 🙂 Investment Management.

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