The good news is that lower rates can justify higher valuations, but as former Morgan Stanley guru Gerard Minack explains, the bad news is lower earnings growth. In Minack's view the rally from the 2011 lows was the equity market factoring in the beneficial part of the story: re-rating on the back of a low discount rate; but, markets are only now starting to focus on the corollary: lower trend earnings growth. With the prospective P/E of the S&P500 is now at an 'ugly' all-time high relative to the medium term EPS forecasts, and downgrades set to continue based on macro weakness, equity valuations suggest this 'correction' is far from over.
S&P500 earnings are now falling. Lower oil prices and a strong dollar are hurting, but the biggest issue seems to be rising labour costs capping margins. In addition, medium-term earnings expectations are also falling – rightly, in my view, given current high margins and the prospect of low growth.
UGLY - Consensus forecasts for 2016 and 2017 are being scaled back faster than usual...
UGLIER - Earnings face well-known headwinds, notably a stronger dollar and falling oil. Cycle indicators, such as the manufacturing ISM, point to further larger-than-usual downgrades to EPS forecasts
UGLIEST - The prospective PE of the S&P500 is now at an all-time high relative to the medium term EPS forecasts
Trade accordingly.
Excerpted from Minack Advisors latest report.