There is some good news though. As Q4 earnings season nears its end, the trend of companies beating estimates has continued. To be fair, companies typically exceed estimates but normally by an average of about 5% based on the past 60 earnings seasons for the S&P 500. However, in the past three earnings seasons, the average has been about +19%. If the magnitude of positive surprises continues, then perhaps the market is not as expensive. That is a BIG if though.
The other good news is that earnings are steadily growing. And this could accelerate as the vaccine rollout allows industries most impacted by the pandemic to join the road to recovery. This may be partially reflected in 2021 estimates, but we would expect the trend to carry into 2022.
Do Valuations Matter?
This is a fair question. Valuations have been at these elevated levels for six months now and in case you hadn’t noticed, the market has continued to trend higher. In Q1 of 1998, S&P 500 valuations moved above the 90th percentile. Two years later the market was up 36%. Valuations do not mark tops or bottoms, however they do have an impact on returns expectations. Looking at the data back to the 1930s, if you buy when the S&P 500 is in the bottom quartile of valuations, you did much better than if you bought at the top valuation quartile (Chart 2). Given the PE ratio is 23x, valuations are well in the top quartile of over 17.3x.
Charts are sourced to Bloomberg L.P. unless otherwise noted.
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