According to FactSet, the five-year average for the forward 12-month P/E multiple for the S&P 500 is 16.3. Today, the forward 12-month P/E multiple is 15.9 versus 16.8 at the start of the fourth quarter.
On the surface, the S&P 500 appears to be undervalued. Why, then, hasn't there been a rush to buy the sell-off that has taken the "P" of the S&P 500 down 5.0% this month?
The answer has a lot to do with the "E" in the P/E multiple.
The Catch-All Factor
Most explanations for the stock market's difficulties will invoke hot-button issues like the following:
- The economic slowdown in China, which registered this week when China reported its slowest annualized GDP growth (6.5%) since 2009.
- The increasing likelihood that a 10% tariff on $200 billion of imported Chinese goods to the U.S. will be increased to 25% on January 1 and be followed by a new tranche of tariffs on another $267 billion of imported Chinese goods.
- Worries that Italy's populist government will cavalierly ignore EU budget rules and risk inviting a debt crisis that poses systemic financial risk.
- The uncertainty surrounding the UK's Brexit plan.
- The uncertainty related to trade negotiations between the U.S. and the EU.
- Geopolitical angst related to the allegations that Saudi Arabia ordered the murder of Washington Post columnist Jamal Khashoggi [note: King Salman of Saudi Arabia has denied any involvement].
- Concerns the Federal Reserve will increase the target range for the fed funds rate too much and trigger a recession.
- The strong dollar and the difficulties it poses for emerging markets and U.S. multinational companies.
- The uncertainty surrounding the mid-term election outcome.
That's not intended to be a comprehensive list. Those factors, however, have all served as hurdles for buy-the-dip efforts.
Another factor that isn't a macro factor per se is the difficulties that have been experienced by the market's favorite, and, some might be bold enough to say, former leadership stocks.
Stocks like Netflix (NFLX), Amazon.com (AMZN), Apple (AAPL), Facebook (FB), Alphabet (GOOG), Boeing (BA), and Visa (V), to name just a few, have not acted well, which has rattled investor confidence.
At the end of the day, though, there is a catch-all factor connected to the hot-button issues and the cold shoulder the momentum stocks have given investors.
That factor is the earnings outlook.
This market might not say it directly, yet it is acting right now as if it has some real concerns about the path of earnings growth estimates.
Accordingly, there has been multiple compression at a time when third quarter earnings are tracking up 19.5%, according to FactSet, following 25% increases in the first and second quarters.
If this market was fixated on what companies have done for them lately, the dimensions of a V-shaped recovery would be more apparent.
This market, however, is looking ahead and it's not sure if it is going to like what it sees.
That's the connection one can draw from the continued underperformance of the Dow Jones Transportation Average, the Philadelphia Semiconductor Index, the iShares U.S. Home Construction ETF (ITB), and the auto stocks. They are all intricately linked with economic activity, yet they have been de-linked from this bull market.
What It All Means
The S&P 500 may have fallen 5.0% this month, yet it is still up 3.6% for the year before dividends.
On the bright side, then, it is still a bull market. It's just not a stampeding bull market like it seemed to be a few weeks ago.
It is caught up in a period of price dislocation that has shaken investor sentiment and the inviolate standing of the major indices.
The falling "P" has been the driver of the multiple compression since prices have fallen further than earnings estimates. Actually, the 12-month forward earnings estimate hasn't fallen. It has risen 0.4% since the start of the fourth quarter, according to FactSet.
The discounted market multiple looks appealing, yet it hasn't put a buy-the-dip charge in the market because investors have their concerns about the "E" getting knocked off its high-growth perch.