Thursday, November 15, 2018

Chart of the Week: Sources of S&P 500 Total Return

Hilliard Lyons’ Investment Strategy & Research team is dedicated to supporting you and your Wealth Advisor. We provide investment guidance and help you separate meaningful news from idle noise via timely market commentary.

Sources of S&P 500 Total Return

Recent Multiple Decline at Odds with Earnings Forecasts

Broadly speaking, market return can be broken down into three major components: dividend, earnings growth, and change in price-to-earnings ratio (P/E). Dividends and earnings roughly approximate income generated by the underlying firms, while a change in P/E represents shifting market sentiment. It tracks the price move in relation to earnings; a contracting P/E indicates prices are dropping relative to earnings, and vice versa. From a valuation perspective, a lower P/E indicates a cheaper stock market.

In the chart above, we can see that the contraction of forward P/E in YTD 2018 is the largest since 2009. However, the 2009 contraction was roughly matched by the decline in forward earnings projections; that is, the price drop was substantiated by the notion of less future earnings. That isn’t the case today. Thanks in part to tax cuts and a strong economy, forward EPS projections have risen consistently throughout 2018.

In fact, with over 90% of the index reporting Q3 earnings, the S&P 500 is seeing sales growth of 8.32% and earnings growth of 26.77%, one of the best quarters since the 2008 crisis. That said, forward P/E has dropped from 18.3x at the start of 2018 to 16.2x currently, its lowest since 2015.* Should earnings expectations prove accurate, stocks are looking attractive vs. recent history.

*S&P 500 sales and earnings growth and forward P/E data per Bloomberg.

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