As we await Tuesday's election outcome, lets have a peak at one of the fundamental metrics that we like to look at: The ratio of stock prices relative to company earnings.
With 85% of S&P 500 companies having reported 3rd quarter earnings thus far, the actual plus expected (for the 15% who have not yet reported) earnings data (according to Factset) is +2.7% (year over year). At the end of the 3rd quarter, the expected number was -2.2%. This will be the first positive earnings quarter since the 1st quarter of 2015.
At the same time, the S&P 500 has slipped by about 5% since it made new highs in late August.
In essence, stock prices are now cheaper on a relative basis: the 12 month forward price to earnings (P/E) ratio has dipped to 15.9 times from highs of above 17 times when stock prices were higher.
However, historically, the 14.3 times average over the last 10 years suggests that prices are still expensive and could move significantly lower before there is reasonable value.
Price action in equity markets has been generally negative and volatility has climbed in the run-up to the election, uncertainty has put investors purchasing decisions on hold and sellers are now in control.
The good news is that we have remained under-weight equities and over-weight cash (cash equivalent, money market, high interest savings), waiting for better value. We have been patient and we believe that we still have room to be patient. After all, our underlying theme for 2016 was to expect more volatility.
It is not just the election, central banks have been reviewing their strategies and fears that they will be less supportive of financial markets concerns with some support for underlying inflationary trends.
The release of US employment data yesterday showed a healthy year over year increase in wages of 2.8%. This will register with the US Federal Reserve when it comes to their interest rate decision making in December, adding impetus to their desire to raise interest rates.
So we (at High Rock) continue to act prudently for ourselves and our clients to not succumb to chasing returns and taking more risk than necessary, waiting for opportunities to get reasonable value into our models and portfolios. That has been our mantra for some time. In fact, that is the nature of our investing philosophy: you do not have to be fully invested at all times. There are times when it is advantageous to shift asset exposure when prices become expensive because it is the nature of markets to get over-sold and over-bought. We add value to our client portfolios using our years of experience (and deep research) to pick the appropriate price points (to buy or to sell).
It is easy work for an advisor to recommend a buy and hold strategy, but we are not advisors, we are a portfolio management company with a very strong understanding of wealth management and that is a clear distinction.
Sometimes that distinction gets blurred, but is like comparing apples to oranges, it is just not the same.
We will make model and portfolio adjustments as we see fit and our clients trust in our judgment to do so. Our track record has justified our philosophy and helped to immunize (as best as is possible) our clients portfolios from volatility. And volatility/fear is high and rising (or greed is low and falling):
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist