Stories >> Economics

Ed Yardeni: Inflation Boosts Earnings & Depresses Valuation



This is an excerpt from our May 10 Morning Briefing.

Over the past year, inflation has been having a positive impact on analysts' consensus forecasts for earnings in 2022 and 2023 but a negative impact on the valuation multiple that investors are willing to pay for those earnings estimates. Needless to say, the former positive effect has been trumped by the latter negative effect. The negative impact reflects the jump in bond yields so far, concerns that bond yields will continue to move higher, and fears that this will all end with a recession.

This clearly hasn't been another one of the garden-variety panic attacks that we have been chronicling in the stock market since 2009. Most of them turned out to be minor, short-lived selloffs. A few were full-fledged corrections. The selloff in 2020 technically was a bear market, but it didn't last very long, and we included it in our list of panic attacks. The S&P 500's selloff to date leaves it still in correction territory, but the Nasdaq is in a bear market. That's because the latter is dominated by Growth stocks that are more adversely affected by rising bond yields than are Value stocks.

The current stock market selloff is also unique because for the first time since former Fed Chair Alan Greenspan invented the so-called "Fed Put" during the 1987 stock market crash, the Fed Put is now kaput. The Fed has long been expected to step in to bail out markets whenever things got tricky. But now it can no longer be counted on to do. That's because inflation hasn't been as serious a problem as it is today since the Great Inflation of the 1970s.

As a result, we are now experiencing a meltdown of valuation multiples in the stock market even though industry analysts are continuing to raise both their revenues- and earnings-per-share estimates. Consider the following:

(1) Revenues, earnings, and margins. S&P 500 forward revenues per share is up 5.1% ytd to yet another record high of $1,749 during the April 28 week (Fig. 9). S&P 500 forward operating earnings per share is up 6.1% ytd through the April 28 week to a record $233. The S&P 500 forward profit margin–which we calculate from forward revenues and operating earnings–edged up to a record 13.4% during the April 28 week.

Here are the ytd growth rates of forward earnings and forward revenues for the S&P 500 and its 11 sectors: S&P 500 (6.1%, 5.1%), Communication Services (-1.2, 3.2), Consumer Discretionary (5.6, 3.4), Consumer Staples (1.4, 3.4), Energy (45.8, 20.8), Financials (3.8, 3.2), Health Care (1.5, 2.6), Industrials (4.5, 4.2), Information Technology (7.0, 5.5), Materials (8.3, 7.6), Real Estate (7.6, 5.7), and Utilities (2.0, 6.2).

Industry analysts obviously didn't get the recession memo. In addition, their estimates imply that most companies are passing their rising costs through to their selling prices. So margins are holding up well, as both revenues and earnings are keeping pace with inflation.

(2) Valuations. The bad news is that none of this seems to matter to stock investors, who've been unnerved by rapidly rising bond yields, which have had a double-barreled negative influence on valuations. Higher yields reduce the present discounted value of future earnings and raise the risk of a recession. So the freefall in the forward P/E of the S&P 500 since the start of this year has coincided with the vertical ascent of bond yields (Fig. 10 and Fig. 11).

The forward P/E of the S&P 500 is down 18.2% from 21.4 at the start of this year to 17.5 on Friday of last week. In the March 8 Morning Briefing, we wrote: "We are giving up on the notion that the S&P 500's forward P/E will hold above 20.0. It is already down to around 19.0. We are now estimating 16.0 by year-end …" We are on course to get there ahead of schedule.

________________

Try our research service. See our Predicting the Markets book series on Dr. Ed's Amazon Author Page. Please see our hedge clause.


Click to Link




Posted: May 13, 2022 Friday 02:28 AM