Is it time to reconsider this monster rally?
With the S&P 500 up 9% in six trading sessions to an all-time intraday high, many are looking at parts of the market as overbought. Others agree, but say it doesn’t matter in this strange mix of election and vaccine news. Who’s right?
On the bullish side, the technical guys are all enthusiastic. Even before Monday’s promising vaccine news, Lowry Research, the oldest technical analysis service in the United States, opined that because of last week’s breakout, “the latest buying opportunity of the advance from the late March bottom is now present.”
However, the extent of the rally in cyclical/value sectors is being hotly debated. Banks are up 15%, energy is up 15% and industrials are up 12% in the last six trading sessions. Many are now trading at valuations that have not been seen in years.
Part of the problem — and the source of the disagreement — is that “value/cyclical” is a diverse group. Citigroup’s Tobias Levkovich notes that there are three “buckets” of value stocks: financials, industrials and the “Covid-impaired groups” like travel and leisure.
The “Covid-impaired groups” have been decimated. Delta Airlines, for example, which was $60 a share before the virus hit, was recently trading at $30, and closed Monday at $36. That’s a rally, but it has so far to go that the recent rise may not be an obstacle: “Any kind of solution to the pandemic really revives their chances, and you’re seeing stocks react significantly,” Levkovich told CNBC.
But other value sectors are seeing valuations — and rallies — that do matter. Bank stocks have also begun moving on higher bond yields. Some bank stocks are trading at multiples above where they have been for the last couple years:
Bank P/E forward multiples: Multiyear highs
- US Bancorp 14
- JPMorgan 13
- Fifth Third 12
- PNC 16
But the biggest movers have been industrials, which even before the vaccine news had been moving as industrial proxies like ISM Manufacturing had been improving. Monday’s rally moved many to new highs (Eaton, Corning, Dover, Ingersoll-Rand) and moved the forward multiples on these companies into territories they have not seen in years:
Industrial P/E/ multiples: All at 10-year highs
- Honeywell 25
- Sherwin Williams 26
- Ingersoll Rand 25
- General Electric 25
- Deere 24
For Levkovich, who began his career as an industrial analyst, this is a sad fact of life for stocks in this space: “You always pay up for them when they have depressed earnings. So the valuation criteria that we look at and which have been the most predictive of stock price performance still says that you want to be in these industrial-type conglomerates, that there’s still opportunity to the upside for performance.”
Don’t tell Wall Street bulls to worry about high P/E multiples. Fundstrat’s Tom Lee is typical: “I think valuation sensitivity is the wrong metric people should have, I think we could still rally another 10% from here,” he told CNBC.
This is an old-school Wall Street ploy: Let multiples rise, because the prospects for an improving economy — and higher earnings — is the classic reason multiples move higher.
Except the market is at an historic high, and much of what has moved, even in the value space, has moved up very fast.
And in case the bulls need more ammunition, you can always pull out the Federal Reserve, which will support the markets, regardless of whether it needs it or not, as Brian Belski from BMO pointed out on CNBC: “I think that stocks are going higher and I think the key thing they have to remember — the Fed has basically signaled we’re going to be here for three years … this is a risk-on period.”
Bottom line: Wall Street is already pricing in a “normalization” of the economy in 2021. You can see it in earnings for the S&P 500:
S&P 500 earnings estimates
- 2019: $162
- 2020 est: $136
- 2021 est.: $168
See? A complete round-trip in earnings. Back to normal. It’s 2019 again.
This reopening story had better be picture perfect.
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