Robert Shiller’s CAPE (Price/10-year simple MA of inflation-adjusted earnings) is at 30.31, the second-highest peak (behind the Dotcom bubble) in 120 years.
PEmax (Price/highest prior 12-month earnings) is far lower at 21.04. I prefer this as a more accurate measure of stock pricing than CAPE. But PEmax is still high relative to the peaks of Black Friday in October 1929 and Black Monday in October 1987.
Forecast earnings for the remainder of 2019 may be slightly optimistic, given recent escalation of the US-China trade war, but the forward price-earnings multiple is lower, at 18.62. The sharp difference between forward and historic PE ratios (as in PEmax) is largely attributable to the earnings hiccup in Q4 of 2018 which is excluded from the forward ratio.
Forecast earnings growth, on the chart below, shows a similar anomaly in Q4 of the current year, caused by comparison to the earnings dip in Q4 of 2018. Forecasts assume that earnings will grow between 7.1% and 7.8% for the rest of 2019, rising to above 11% in 2020.
Their projections seem optimistic.
Year-on-year sales growth is a modest 5.8% for Q1 of 2019 and is likely to continue between 4.0% and 6.0% for the foreseeable future. The spike in sales growth in 2017 – 2018 is a result of recovery from negative growth in 2015 and is unlikely to be repeated.
Operating margins are just as important. Margins recovered to 11.25% for Q1 2019 (89.9% of stocks reported), after a sharp fall in Q4 2018, but it is questionable whether these are sustainable.
Conclusion
Earnings forecasts seem optimistic. With lower sales growth and downside risk in operating margins, long-term earnings growth of between 4.0% and 6.0% is likely. The 30-year average is 6.17% p.a. but low inflation (and a possible trade war) is likely to see us undershoot this.
Forward Price-Earnings ratio of 18.6 is on the high side for expected low earnings growth. A forward PE of 16.0 or less, however, should be viewed as a buy opportunity.
Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters.
Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis.
Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events.
He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.