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Macro Outlook

Signs of Excess

By Elliott H. Gue, on Oct. 28, 2016

Roughly one-third of S&P 500 companies have reported results for the third quarter. Of those, just over 77 percent delivered positive surprises on earnings and 61 percent beat top-line expectations. That may sound like a big positive, but it’s in-line with the S&P 500’s performance at this same time during the second quarter.

Analysts now expect the S&P 500’s third-quarter earnings to shrink 0.4 percent, with a decline of 2.4 percent excluding financials. And Wall Street has become even less sanguine on the fourth quarter and the first quarter of 2017.

At the end of September, the consensus looked for total S&P 500 earnings to grow 6.3 percent year-over-year in the fourth quarter and 14.9 percent in the first quarter of 2017. Currently, those estimates stand at just 5.8 percent and 14.3 percent, respectively.

As if sliding expectations weren’t enough to make you think twice about the health of the market, keep in mind the S&P 500’s current valuation. At 20.2 times trailing earnings and just under 17 times the consensus estimate for the next 12 months, the index trades at a multiple that’s well beyond where it was just before the start of the Great Recession. Those highs, hit in May 2007, reached 15.6 times forward earnings. In fact, the only period in the last 30 years with similar valuations occurred between 1997 and 2000, the height of the tech boom.

Valuations are a terrible short-term timing indicator for the stock market. For example, in the late 1990s, the market continued to rally for years even as many pundits warned about excessive valuations. When those pundits finally were proven correct in March 2000, investors who followed their advice had missed out on the powerful final leg of the 1990s bull market.

However, several signs of excess anchored in corporate debt are just as concerning, and much more meaningful than valuations.

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