Registered Investment Adviser Caleb Lawrence
The major averages continue their relentless narrow march higher seemingly unconcerned about valuation, profits, or fundamentals. To get an idea of just how far ahead of themselves the markets are, consider the Standard and Poors 500 Index. Since the 2009 low this index has jumped an impressive 266%, earnings on the other hand have increased just 98% and have gone effectively nowhere since 2011. Given that the theoretical rational for buying stocks is the discounted purchase of the future earnings stream, that becomes food for thought. Following a period of declining earnings that made for some very easy year ago comparisons, this bar will ramp up notably in the next 12-months. With earnings growth usually overstated by 30% or so the miss-match won’t be trivial. Especially in light of the rapidly receding odds of meaningful tax reform from the increasingly under fire Trump administration. Given the equities markets current valuation levels and penchant for mean reverting something particularly true for profit margins, to quote “Dirty Harry” you have to ask yourself “are you feeling lucky?” Because historically these periods of mean reversion usually coincide with some sort of crisis. In all fairness, it should be noted that low interest rates, accounting rule changes, and debt-funded buybacks have helped to get us where we are today. The benefit of these items is all but exhausted with corporate debt levels at record highs while return on equity has fallen sharply in the last few years. The trend is your friend, until it isn’t. This trend will one day become many an investor’s worst nightmare.