“We have seen this before”, SocGen’s Andrew Lapthorne wrote on Monday, in a kind of pseudo-lament.
What is “this”, you ask?
Simple. “This” is equities rallying despite lackluster profit growth. That was a defining feature of 2019. By all indications, it will be a fixture in 2020 as well, although folks are penciling in a rebound in bottom line growth stateside.
Various explanations have been floated to “explain” 2019’s blockbuster equity gains against a backdrop of flatlining EPS growth.
One such explanation is that although, over the long-term, price performance tracks profits, in the near-term, stocks rally in anticipation of EPS trends. That, Ned Davis suggested last month, helps explain why 2018 was a rough year for stocks even as EPS growth boomed, and vice versa in 2019.
Read more: Prophesying Profits.
Of course, a simpler explanation might be that central bank liquidity has intervened yet again to ensure that risk assets can remain disconnected from fundamentals.
“During various central bank interventions post various financials crises, equities have rallied despite a lack of support from earnings”, SocGen’s Lapthorne goes on to say. Here’s an illustration:
Just as Morgan Stanley’s Mike Wilson last week wrote that “momentum can go further in a liquidity driven bull market”, Lapthorne notes that “although the share price rally in 2019 implies a need for rapid acceleration in profits this year, some market participants argue that as long as central banks are printing money equities can keep rising”.
Indeed. And all efforts on the part of Fed officials to argue that correlation doesn’t equal causation and “reserve management” doesn’t equal QE, it’s hard to ignore this:
One note of caution, though. As Lapthorne goes on to point out, multiples are far more extended now than they have been during previous episodes of central bank largesse bridging the gap between lackluster profit growth and elevated equities.
“In 2011 MSCI World was trading on a forward PE multiple of just under 11x, at the very bottom of it historical range; today MSCI World is on a forward PE of 17x”, he warns.
The irony: The reason valuations are so stretched is that central banks juiced equities in 2019 even as profit growth stalled (or turned negative) in just about every locale you care to mention.