Market Minute - July 14, 2020
by Scott Rosenquist, CFA
The first half of 2020 is now past us and the financial markets have already had quite the year.
The S&P 500 index returned 20.5% in the second quarter marking its best quarterly performance in decades and down just a few percent for the year. Given the large moves in both directions this year, I think now is a good time to review valuation measures for the S&P 500 which is the most commonly used index for the broad market.
The chart below from J.P. Morgan’s Guide to the Markets shows the forward price to earnings ratio for the index as of June 30th. The forward price to earnings ratio (P/E) is one way to look at market valuation. It compares the current price divided by earnings estimates for the next twelve months. It can then be viewed relative to historical levels as this chart shows.
As you can see, the forward P/E ratio is above its long-term average. There are a few things worth noting here. One is the big move last quarter that raised the price of the market relative to earnings. Earnings on the other hand, are based on analyst estimates when considering the forward P/E ratio. I cannot think of a more difficult environment for earnings estimates. Companies will begin reporting quarterly earnings in the coming weeks although the market may not get clarity as forward-looking guidance has been pulled for many companies given the enormous uncertainty surrounding the economy.
The second half of the year will be eventful as the election approaches and the economy reopens among a new wave of COVID-19 cases. This should keep markets volatile. As the chart shows, the equity market does not appear cheap and the earnings picture remains unclear. While valuation is not a great timing tool, it does help paint the picture for longer term returns. Given the level uncertainty on these important issues and full valuations by most metrics, we remain cautious going into the second half of the year.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and / or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete or accurate. Investments carry risk of loss including loss of principal. Past performance is never a guarantee of future results.