The most recent inflation data release and the U.S. consumer price index were on investors’ minds Wednesday, as the index climbed 0.4% in December, a value in line with a Dow Jones estimate.
Stocks and index ETFs rallied strongly in the first week of the new year, but have begun consolidating since then.
“The market rally has taken a break this week,” said Mark Hackett, chief of investment research at Nationwide. He noted, however, that “sentiment and risk indicators continue to reflect investor optimism, with credit spreads at their tightest level since before the pandemic, fear & greed indicators at elevated levels, and the put/call ratio near historic lows.”
By Mark Hackett
The equity market has been remarkably resilient since 2019 even with unprecedented disruption. The S&P 500® Index has returned more than 50% since January of last year despite the expectation for no earnings growth between 2019 and 2021. As a result, the price-to-earnings ratio for the S&P 500® based on earnings over the next twelve months is currently at 22. That’s nearly 40% higher than the average forward P/E of 16 over the past 25 years and near the peak of 24 seen during the late 90s technology bubble.
The chart above frames the stock valuation argument differently. It compares the index value of the S&P 500® to the average hourly earnings for individuals. At the end of November, it would take 146 hours for the average person to make enough to buy a “share” of the S&P 500®. This ratio is double the level seen in 2012 and more than seven times the level of the 1980s, showing the degree to which equity returns have outpaced wage growth.
Thoughts
Equity market strength continues, with gains in four of the past five weeks, and most major indexes at record highs. Leadership continues to broaden, with strength in the past month driven by emerging markets, small caps and value indexes. Despite incredible disruption, the S&P 500® Index is on pace to return 15% this year, which would be the 35th-best result in the 92-year history of the index.
Investors are facing clashing cycle indicators, as the unique conditions of the current cycle have created an environment reflective of both early cycle and late cycle conditions. The unprecedented drop in economic activity earlier this year drove the economy in recession, while the rapid decline in equity prices resulted in the fastest bear market on record. The speed of the economic and market recovery has been equally quick and impressive. Many current conditions are consistent with early cycle activity, including strength in value (+10% in past month) and small caps (+14% in p