While US consumer spending, the US economy’s fundamental driver, fell 13.6 per cent in April, and recorded the steepest decline since 1959, the data is now a month old. More recently, the US Institute for Supply Management’s (ISM) Manufacturing Index for May rose to 43.1 from an 11-year low of 41.5 in April, suggesting the economy is rising up off the matt after being KO’d.

Optimism in the US about the relaxation of lockdown restrictions at both a State and business level, as well as hope for a coronavirus vaccine, has now seen the S&P 500 index rise 36 per cent from its March lows. Despite the unlikely event of a full recovery to pre-crisis levels of economic and business activity any time soon, the S&P500 has now cut its losses for the calendar year to just six per cent.

The gains are despite S&P 500 earnings forecast to fall 20 per cent year-on-year over the next four quarters, according to analysts surveyed by Refinitiv. This represents a significant turnaround from the 10 per cent growth forecast before COVID-19 hit.

Consequently, the S&P 500 now trades at 21.6 times expected earnings, putting its forward P/E into territory last seen during the dot-com bubble.

That P/E ratio of course will fall as a consequence of an expected bounce in earnings in 2021 and 2022 but the losses being experienced today will reduce total earnings over the next decade. We have previously estimated the worst-case scenario for earnings would produce a decline in aggregate intrinsic value of about 12.5 per cent.

The very high price to earnings ratios of both the ASX 300 and the US S&P500 also reflects the gains in the market capitalisations of businesses with high earnings power and healthy unleveraged balance sheets. It is towards these companies that most of the capital appears to be flowing. Indeed, to that point, it is worth noting that Barron’s recently reported that the Nasdaq’s ten largest stocks, which includes Facebook, Amazon, Apple, Netflix, Google, Intel, Nvidia, and Cisco have increased their market capitalisation by almost US$1 trillion.  This is triple the total gain of the remaining 2990 companies.

The debate over current market valuations comes back to the definition of what a recovery is. If recovery is anything better than the economy being knocked flat on the boxing mat, then we are in recovery. If, however, ‘recovery’ is a return to full strength, we are some way off recovering.

When the anticipated fall in earnings emerges it is possible that some volatility returns but equally, the idea of limitless fiscal and monetary policy stimulus, must be considered because unless there is a meaningful second wave of infections, the ‘re-opening’ data both here in Australia, and importantly, in the US, is also emerging and some of it is better and earlier than expected.

We also know with certainty that this year the Trump Administration is going to record a fiscally-irresponsible deficit surpassing any previously established. Consequently, the US Federal Reserve will be forced to buy bonds protecting the world from a flooded bond market, rising yields and cratering asset prices.

With an unwitting debate about defining recovery still underway, we expect a return of some volatility, and if it emerges it will deliver cheaper prices with the concurrent benefit of greater clarity about underlying business prospects. However we are also heavily invested in high quality business with bright prospects and leverage to an economic recovery.

The Montgomery Global Funds and Montaka own shares in Alphabet  Facebook and Apple. This article was prepared 02 June with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial advice.

by Roger Montgomery Posted in Market commentary

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by Roger Montgomery Posted in Market commentary

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by David Buckland Posted in Global markets, Market commentary

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