Market Math: Do stock valuations matter in Trump World?

Market Math: Do stock valuations matter in Trump World?

This file photo taken on August 6, 2015 shows now president-elect Donald Trump flashing the thumbs-up as he arrives on stage for the start of the prime time Republican presidential debate at the Quicken Loans Arena in Cleveland, Ohio. (AFP PHOTO / MANDEL NGAN/AFP/Getty Images)

The stock market rally following Donald Trump's surprise White House win has made an already expensive U.S. stock market even more so, raising questions about whether Wall Street is pricing in a too rosy financial scenario.

Wall Street had been warning that stocks were getting rich relative to corporate profits – and that was before the presidential election. Since then, the Standard & Poor’s 500 stock index has rallied nearly 3%, stretching valuations even more. Since Election Day, the price-to-earnings (P-E) ratio, a common metric used to measure whether stocks are cheap or overvalued, have swelled further to 17.1 times earnings from 16.2 times, which is well above the long-term average of 15.3 over the past 30 years, according to Thomson Reuters.

To be sure, the market is less expensive than during the peak of  the dot-com-stock boom in March 2000 when the S&P 500 P-E reached 22.7 times earnings, and well above the 10.4 multiple following Lehman Brothers' bankruptcy in October 2008 and the 11.7 P-E at the bear market low in March 2009, Thomson Reuters data show. (Other P-E metrics, which are calculated slightly differently, point to a market that’s even more expensive relative to historical norms.)

So, is all the good news already priced into shares? Or will investors continue to pay up for stocks -- causing so-called "P-E expansion" -- amid hopes that Trump’s plan to slash taxes, reduce costly regulations and spend big on infrastructure projects will lead to a stronger economy and fatter profits for U.S. companies.

“The market is pricing in great expectations,” says David Kotok, chief investment officer at Cumberland Advisors. “There is little margin for disappointment. From now on more care is needed. The tailwind of a Trump victory has morphed into a light breeze.”

The more bullish take is that Trump’s policies will result in a big enough improvement in economic growth and corporate earnings to make any short-term claims of overvaluation irrelevant.

“When there is a quantum shift in growth expectations, the arithmetic of P-E multiples fails to capture the value in stocks,” argues Don Luskin, chief investment officer at TrendMacro. “Why look at this quarter’s earnings, or for that matter why just look one year ahead, to appraise what a company might earn? If America is really going to be great again, stock prices should look to above-trend earnings growth that could last for several years. That will make stocks appear expensive, but they’re really not.”

For now, investors are driving stock prices – and valuations – higher on a bet the nation’s financial picture will improve markedly. If that bet is correct, P-E ratios will fall as earnings rise, adds Brian Belski, chief investment strategist at BMO Capital Markets.

Jim Paulsen, citing a different perspective, says the stock market’s current valuation is “not excessive.”

Historically, he says, in bull markets the market has been able to sustain P-Es at around 20 times earnings minus the annual rate of core consumer price inflation. “Currently,” he says, “core inflation is 2.1% but I think it is headed for 3%, which means a P-E of about 17 is probably a sustainable multiple for the overall market.”

The key factor, Paulsen adds, is how corporate earnings actually come in.



Add Comment

all comments

  Other news

more
Texas deaths are grisly reminder of human smuggling crisis

Texas deaths are grisly reminder of human smuggling crisis..

25-Jul, 21:30

James Mathew Bradley Jr., left, arrives at the federal courthouse for a...

Idris Elba crowned Rear Of The Year 2017 as Rachel Riley's bum also picks up top prize – with Prince Harry and Carol Vorderman rounding out the top 5

Idris Elba crowned Rear Of The Year 2017 as Rachel Riley's bum also picks up top prize – with..

25-Jul, 08:53

The Luther actor has been named as having the Rear Of The Year 2017. He...

Beijing urges halt to energy exploration in South China Sea

Beijing urges halt to energy exploration in South China Sea..

25-Jul, 12:50

Vietnam has reportedly stopped oil drilling in the disputed part of the...

Love Island: Camilla Thurlow reveals she is RELIEVED 'past relationship' with Prince Harry didn't work out as Jamie Jewitt claims he isn't threatened by the royal

Love Island: Camilla Thurlow reveals she is RELIEVED 'past relationship' with Prince Harry..

26-Jul, 00:10

After being placed as runner-up in this year's Love Island, Camilla...

Erendira Wallenda to hang out of a helicopter by teeth and toes over Niagara Falls

Erendira Wallenda to hang out of a helicopter by teeth and toes over Niagara Falls..

15-Jun, 07:24

Erendira Wallenda, the wife of famed high wire artist Nik Wallenda, will...

First Love Again Episode 51

First Love Again Episode 51..

07-Feb, 11:04

The following First Love Again Episode 51 English Sub has been released....

Video shows aftermath of alleged Syria chemical attack

Video shows aftermath of alleged Syria chemical attack..

04-Apr, 22:40

Video released by media activists in Syria shows the moment a hospital...

Iraqi's Shiite militias launch anti-IS push west of Mosul

Iraqi's Shiite militias launch anti-IS push west of Mosul..

12-May, 05:48

An Iraqi official says the country's Shiite-led militia force has...