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US MARKET CALL: Stocks Getting Cheaper As Earnings Outpace Prices
Stocks are cheaper than they were in January. S&P 500 forward earnings has risen twice as fast as the S&P 500 stock price index so far this year. So the forward P/E has declined as the index rose to record highs. The impetus was FEMO (fabulous earnings momentum) as opposed to FOMO (fear of missing out). Investors are getting more earnings for their money than they were eight months ago. Here's more: I. Performance. The S&P 500's forward earnings is up 24.9% ytd versus a 12.1% gain in the index, which has pushed the forward P/E down 9.9% (chart). Forward earnings has risen almost uninterrupted this year, while the price index has stalled and pulled back repeatedly. One would expect earnings momentum this strong to be showing up in the price action of the S&P 500’s biggest earnings producers. It isn't. The Magnificent-7 is up 2.0% ytd versus 16.3% for the S&P 500 ex-Mag-7 and 12.1% for the index (chart). II. Earnings. The 2027 analysts' consensus earnings estimate may be leveling off around $410 after climbing all year (chart). We expect it to finish this year near $415.00. The latest forward earnings of $393.28 should converge to our estimate as the year progresses. The S&P 500 should hit 8,400 by year-end if the forward P/E edges back up above 20.0. Analysts’ quarterly earnings expectations are still rising (chart). Projected y/y EPS growth rates are up to 23.2% for Q3 and 27.4% for Q4. Q2's 47.4% is inflated by the mark-to-market (MTM) gains at Alphabet and Amazon that we have flagged for several weeks. Excluding these MTM gains, Q2 earnings rose 25.7%. S&P 500 forward earnings is growing at 35.9% y/y, while forward revenues is up 13.1% (chart). That gap reflects widening profit margins. A margin gap this wide has appeared in the past only after recessions and bear markets. This pattern shows up early in bull markets rather than late. This time, the difference is that the margin expansion is not the usual cyclical bounce off a trough. In our view, it reflects structural productivity gains. Consensus long-term earnings growth (analysts' expected five-year annual growth rate) is currently 25.0%, nearly double the historical average of 12.8% (chart). This signals irrational exuberance in analysts' earnings expectations. However, stronger-than-expected actual earnings have driven it. III. Earnings Breadth. Forward earnings are at a record high for the S&P 500, the S&P 400, and the S&P 600 (chart). FEMO is not just a LargeCap story. The breadth of earnings has improved. The dispersion in forward revenue and earnings increases is very high (chart). IV. Valuation. Earnings and expected earnings keep rising faster than prices, so multiples keep falling. The Magnificent-7's forward P/E is down to 23.7, the narrowest premium to the S&P 500's 19.7 since April 2025 (chart). The S&P 400 MidCaps at 16.5 and the S&P 600 SmallCaps at 15.7 are cheaper still, and they continue to outperform. Information Technology has had an excellent earnings season, and its multiple barely reflects it. The sector's forward P/E is 21.1 against 19.8 for the index (chart). This is not 1999, when tech stock price gains reflected overly inflated valuations (FOMO) that soon after deflated. The 10-year Treasury yield is moving toward the top of our 4.00%-5.00% "old normal" range and toward the S&P 500's forward earnings yield of 5.08% (chart). Convergence here does not mean that the forward P/E has to fall. Earnings are rising fast enough to keep the earnings yield ahead of the bond yield. V. Sentiment. The Investors Intelligence bull/bear ratio is 3.62 against its 2.60 average, while the AAII ratio is 0.89 against its 1.18 average (chart). Institutional investors are bullish, while retail investors—scared out of the stock market earlier this year—haven’t ventured back. VI. Nvidia. We asked our colleague Joe Abbott to look at what effects Mag-7 stock Nvidia has on Q2 S&P 500 earnings ahead of its report this week. Excludingmark-to-market (MTM) accounting effects, S&P 500 Q2 earnings growth is 28.3% y/y including Nvidia and 22.4% without it. Nvidia accounts for 15.1% of the ex-MTM y/y change in total Q2 earnings, a close second to Micron's 16.3%. Nvidia's share of annual S&P 500 earnings rose from 0.3% in 2019 to 4.9% last year, and analysts expect it to be 7.2% this year. How much Nvidia’s earnings beat analysts’ expectations is likely to determine the stock market’s reaction to the report. Across a sample of 21 AI-exposed companies we track, those beating earnings estimates by more than 10% rose 4.2% on average on the day of the earnings report and rose 7.2% over five days. Those beating by less than 10% fell 1.2% and 3.0%, respectively. The bar companies need to clear to earn big share price reactions has been raised from simply beating the consensus forecast to beating it by a wide margin.
Freaking Out Over The Bond Market
I. Bonds On Wednesday, the Treasury Department announced that it was doubling the size of its effort to buy back Treasury securities with maturities between 10 and 30 years, to $4 billion per operation. Long-dated Treasury borrowing costs had been rising sharply amid competition for capital from AI data-center builders, and on worries about government deficits. US sovereign debt hit a record $40 trillion on Wednesday. Bond yields fell slightly on yesterday's news. Today, they edged back up (chart). So, has Treasury Secretary Scott Bessent's attempt to stabilize the bond market already failed? Does this mean that a government debt crisis is imminent? That seems to be the reaction of a few commentators, especially those who have been predicting such a crisis for many years. As we noted yesterday, Treasury buybacks are structured to repurchase older, less liquid ("off-the-run") government bonds from primary dealers, freeing up dealer balance sheets and improving secondary market functioning. Bessent isn't trying to lower bond yields. Rather, he is trying to stabilize them so Treasury auctions go smoothly, particularly yesterday's 20-year auction. So we are sticking with our base-case scenario for the bond market. We expect that the 10-year Treasury yield will remain in a 4.00%-5.00% range through the end of this year and next year. Our relatively constructive view reflects that Bessent's Treasury is following former Treasury Secretary Janet Yellen's 2023 playbook by financing more of the deficit in the Treasury bill market (chart). In effect, the Treasury is forcing the Fed to buy Treasury bills to keep the federal funds rate from rising. In the short term, the recent drop in the Citigroup Economic Surprise Index should also help stabilize the bond market (chart). II. Stocks Stock prices remain near their recent record highs despite jitters over the recent rise in bond yields (chart). We recently observed that according to the Fed's Stock Valuation Model, a 5.00% Treasury yield implies that the fair value of the forward P/E of the S&P 500 is 20.0, which is where it is now. The recent pullback has been widespread. Nevertheless, we still expect that the Impressive 493 will continue to outperform the Magnificent-7 this year and probably next year too (chart). The two bull-bear ratios we monitor are mixed (chart). Collectively, they suggest that the current pullback should be modest. III. Inflation Commodity prices suggest that significant inflationary pressure remains in the pipeline. Diesel prices have soared more than crude oil prices this year (chart). Metal prices are also up sharply on AI-related demand. Wheat prices are rising amid concerns that Russia will block Ukraine's grain exports. The regional prices-paid and prices-received indexes for the NY and Philly Fed districts edged down in August, but remain elevated (chart). IV. Economic Indicators Meanwhile, the economy continues to perform well. The Index of Coincident Indicators (CEI) rose 0.2% m/m to a new record high in July (chart). S&P 500 forward earnings is highly correlated with the CEI. The former has been rising faster than the latter in recent months. The spread between the growth rates of forward earnings and the CEI is highly cyclical and currently shows profits outpacing the CEI (chart). That is consistent with profit margins, which are rising rapidly to record highs. July's average business indexes for the NY and Philly Fed districts are soaring in August (chart). The initial and continuing unemployment insurance claims data series remain subdued (chart).
On Retailers, Insurers & AI Scientists
The tides of consumer spending have shifted toward clothing and household goods and away from cars, homes, and casinos. At least that’s what the ytd performance stats of industries in the S&P 500 Consumer Discretionary sector indicate, Jackie reports. Supporting that narrative: A glowing management update from Target, which reported better-than-expected results this week. … Also: A look at the federal investigation into TWG Global’s companies. Could it be the first of many issues with insurers owned by large money management firms? … And: Claude and Rosalind don lab coats to help advance science.
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