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This is why the stock market selloff may be overdone

Publication Date: 11 Dec 2018 - By Michael J. Kramer By Michael J. Kramer
Actionable
Differentiated

Equity Fundamental Technical Analysis Macro Equity USA

The market continues to be extraordinarily volatile, but earnings for 2019 are still expected to be robust and grow around 10% according to the latest data from Dow Jones S&P Indices. The most recent revisions as of 6 December suggests that US earnings will increase next year to $174.01 per share up from $157.52 per shares in 2018. With the S&P 500 closing at 2,633 on 7 December, the S&P 500 is now trading at 15.1 times 2019 earnings estimates and is now the lowest the multiple thus far in 2018.

Data: Dow Jones S&P Indices

Too Cheap?

Assuming earnings do not see a meaningful deterioration in the coming months, the current earnings multiple on the S&P 500 is at the lower end of the historical range since 1989.

Data: Dow Jones S&P Indices

Slowing Growth

Growth in 2019 is expected to moderate but as the chart below shows it is still very healthy growth based on the comparison in the past.

Data: Dow Jones S&P Indices

No Growth in 2019?

Even if we were to assume no growth in 2019, the S&P 500 would be trading at a PE ratio of 16.7. At its current valuation earnings would have to fall by 24% from current estimates of $174.02  in 2019 to $131.65 for the S&P 500’s PE ratio to rise to 20. It would wipe all the earnings growth seen in 2018 from the tax cut. At this point, although GDP is moderating, there are no signs to suggest the economy is going over that type of cliff. It would seem the equity market is acting in an extremely irrational way at this point or there is something dire lurking that is not clear.

Apple

Even when we look at some of the largest companies that make up the index, earnings estimate reduction have been small. Apple which is probably the at the center of the storm, with all the iPhone worries has hardly seen its earnings estimates reduced. The stock has fallen 26% since 1 October, yet earnings in 2019 and 2020 have dropped just 3% for each year.

AAPL data by YCharts

Microsoft

Microsoft earnings estimates have increased since the end of September.

MSFT data by YCharts

Amazon (AMZN)

Amazon’s earnings estimates have also increased since the end of September for 2018, 19 and 20.

AMZN data by YCharts

Alphabet (GOOGL)

Alphabet’s earnings have fallen modestly.

GOOGL data by YCharts

JPMorgan (JPM)

Even when looking at JP Morgan its earnings outlooks is still stable as well.

JPM data by YCharts

Johnson & Johnson (JNJ)

Johnson & Johnson’s earnings estimates have also remained flat.

JPM data by YCharts

ExxonMobil (XOM)

Exxon may be the wildcard in the group here. Obviously, with oil prices collapsing Exxon may see a considerable impact. But then again, they also have a huge natural gas business. But to this point estimates have not changed.

XOM data by YCharts

Facebook (FB)

Facebook’s earnings have fallen, and they are down considerably since July.

FB data by YCharts

There are far more companies than the ones I have highlighted above, but these the among the largest in the S&P 500. These are the companies that carry the most significant weight, and in some cases, there seems to be a disconnect. It would suggest that S&P 500 has a big rebound on the way or analysts’ estimates are way too high and have much further to fall.

Disclaimer: The author and the clients of his firm - Mott Capital Management - own AAPL and GOOGL shares.

Disclosure:

I have positions in the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

I agree with the terms and conditions of ReachX

This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

Michael J. Kramer

 

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