With about 25% of the S&P 500 companies having reported 4th quarter earnings so far this month, we have had some good news and some bad news. According to Bank of America, the good news is that 73% of companies have beaten expectations on both earnings per share and total sales. This is tracking right about the same pace as last quarter. Although we have pointed out that the bar has purposefully been set low for many of these companies just so they can “beat” expectations come reporting time, the numbers are still remarkably resilient considering the circus that our socio-economic and political circumstances has devolved into.
As far as the bad news, we are seeing net profit margins drop year over year. Margin contractions historically are indicative of the end of a growth cycle. This “growth cycle” post shutdowns is obviously unique, so take all analysis with a grain of salt. Now, the strangest stuff going on is reminiscent of the dot com bubble of 2000. As an aggregate, companies that are outreporting expectations on earnings day are underperforming the stock market the next day. Conversely, companies that are underreporting expectations on earnings day are outperforming the stock market the next day. This counterintuitive market action was last seen to this degree in dot com days.
Some of the valuation measures of the stock market relative to the 2000 dot com peak are concerning as well. Although we didn’t coin the term, we agree that the stock market is currently in a “melt-up” phase that no one can predict the length or magnitude of – only time will tell. The valuation of price to earnings is an oversimplified snapshot of the market, but it can be telling of where an overall market is from 20,000 ft. The price to earnings ratio of the S&P 500 is challenging that of the dot com boom. Take a look…
There are a lot of variations in the underlying conditions between now and 2000. Most obviously are the actions of the Federal Reserve which are recklessly supporting all asset prices. In addition to that, the situation of coming out of Covid lockdowns may lend for a rally in the earnings side of this equation in the next couple quarters. So, we still see upside to the “melt-up” but the danger is growing…
Overseas we see a situation developing in the Chinese markets (and other Asian markets) that is similar to ours. Their central bankers have pushed AMAZING amounts of “liquidity” into their system to support asset prices. This has been going on for more than a decade, yet it seems that just now their melt-up may be beginning. The major indexes in the China market are trading more like 12 times earnings, which is not only a bargain with respect to the American indexes, but even with respect to the same Hang Seng pricing history.
No one knows how long these asset markets are going to melt up. Of course, we worry about a debt driven rally under false premises – but that’s what we have and for now it is working.
Regards and good investing,