Market bears have been calling for a correction – in some cases, by as much as 20% – since the start of the year. So far, they have been wrong. Perhaps the best reason is that unlike past calms before the storm, this market isn’t that expensive.
The S&P 500 is currently trading at 14x next year’s earnings. That’s about the same valuation that the market traded at in 2003 when the S&P 500 averaged 965 points for the year. Investors who accepted the 14x multiple and held their portfolios constant benefitted from a 9% return in 2004, followed by another 3.0% and 3.5% respectively in the two subsequent years, pocketing a compounded return of over 16%.
Macroeconomic tailwinds also bolster the case for a multiple expansion. Aside from the August jobs report, the US market has added over 200,000 jobs each month since March 2014. This compares to an average 150,000 job gains per month, on average, from the summer of 2011 until February of this year. In addition to the nominal job gains, the U-6 unemployment rate has begun to contract. Unlike U-3, which is the sole number reported by media outlets, U-6 includes the underemployed and discouraged workers in its data. U-6 has steadily dropped from 17.5% in 2010 to 12.1% today. However, the rate was a mere 8% in the spring of 2007, so there is still a long way to go before the economy’s labour force returns to a healthy level.
Lastly, Fortune 500 companies are earnings record profits. This quarter, it appears that total operating earnings will equate to $29.45 per share. By contrast, this same comparable quarter earned $24.06 in 2007 prior to the financial crisis.
With reasonable equity valuations, macroeconomic tailwinds, and record earnings, this market is not overvalued and can continue to trade higher from these levels.
