Jonathan Golub of Credit Suisse sent an April 1 public market note. He said: “With multiples stable, the market’s entire advance can be explained by improving earnings.” We agree. The S&P 500 P/E ratio is essentially unchanged for the last three quarters. We also agree that it is high by traditional metrics. Jon wrote, “21.8x today, well above long-term averages, and the highest level in over 50 years, excluding the Internet bubble period (about 21).”
But comparisons with the tech stock bubble period (1998–1999–2000) also have one major difference. Then interest rates in bonds were much higher than present rates. Example: today the very highest grade credit quality tax-free municipal bond is yielding under 2%. In 1999, we witnessed investors selling 6% tax-free bonds and using the proceeds to buy tech stocks at double and triple the p/e of today’s markets.
Now, we’re about to see the reporting of first-quarter 2021 earnings. They will be reported daily starting this week and they will include the effects of the early robust stages of this economic recovery. They will also invite comparisons with the first quarter a year ago. Remember that it was the second quarter of last year that really delivered the COVID shock. So, the comparison of this quarter over Q1 of last year has important information for investment analysis.
Our expectation is for a series of pleasant earnings surprises. If we’re right, the stock market is heading higher, and the increasing upward momentum will be earnings driven. We see confirming evidence in the accelerating upward direction of the profit share as estimated in the GDP accounts. Here’s the link to the St. Louis Fed database: https://fred.stlouisfed.org/series/CPATAX. You can see the all-time high in Q3 and a slight decline in Q4. We expect Q1 and all of 2021 to surge to new all-time highs in this series.
History suggests that a rising and accelerating upward profit share of GDP translates into a rising and upwardly accelerating trend in stock prices. At 4000 on the S&P 500 with earnings expectations at about $200 and rising, we remain bullish. Translated into action: we remain fully invested in our US ETF accounts and quantitative strategies as we start the second quarter of 2021.
David R. Kotok
Chairman of the Board & Chief Investment Officer
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