Does this Chart Spell Doom for the S&P 500 Index?
It has been an impressive eight-week stretch for the U.S. stock market, with the S&P 500 Index staging one of its best relief rallies of the past three decades. Investors expecting to ride out another bull market should tread carefully now that the latest earnings forecasts are in.
The recent run of good fortune has come largely on the back of better than expected corporate earnings as well as signs of progress on U.S.-China trade talks. But these catalysts could become headwinds in the near future.
Case in point: FactSet recently issued grim guidance for S&P 500 companies, forecasting a year-over-year drop in earnings during the first quarter of 2019. The research firm’s rationale for the downgrade comes from the so-called bottom-up earnings per share (EPS), which is “an aggregation of the median EPS estimates for all the companies” in the S&P 500 Index. This figure declined by 4.1% in January, a much bigger decline than the five-year, ten-year and 15-year averages.
All 11 primary sectors tracked by the S&P 500 recorded a decline in their bottom-up EPS estimate during the month of January. The biggest losses were reported by energy and information technology, the S&P’s largest and fifth largest sectors, respectively.
That leads us to the following scary chart, which appeared on the Quoth the Raven Twitter feed on Friday:
Forward earnings are a forecast of a company’s next-period earnings, usually to completion of the current fiscal year or next fiscal year.
Related reading: The January Stock Rally Could Face a Painful Reversal.
Watch Out for 2,800
Morgan Stanley, one of America’s largest banks, is warning investors not to “get caught up in price momentum” of the latest rally. The warning comes as the S&P 500 is once again approaching 2,800, a level where rallies come to die.
While valuation isn’t a reliable predictor for market timing, the headwinds posed by 2,800 are compelling. Combined with dismal earnings guidance, it’s likely that market fundamentals will detract from the latest rally attempt.
If the S&P 500 does go beyond 2,800, its valuation based on 2019 average per-share earnings will be 16.5 times forward earnings. As Bloomberg notes, that’s the average reading of the past five years and a strong sign that stocks are becoming overvalued.
“Don’t get caught up in the price momentum, as if the market is telling you something that may happen,” Mike Wilson, a strategist at Morgan Stanley, told Bloomberg TV. “The data isn’t improving, and the data probably isn’t going to improve over the next two to three quarters, and that’s going to create uncertainty again when you’re trading at 2,750-2,800.”
Featured image courtesy of Shutterstock. Charts via Barchart.com.