If Markets Are Up, Why Are Valuations Down?

Summary

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Podcast Summary: WSJ Your Money Briefing

Episode: If Markets Are Up, Why Are Valuations Down?
Date: August 10, 2018
Host: J.R. Whalen
Guest: Michael Wersthorne, Wall Street Journal Markets Reporter

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Episode Overview

This episode explores a market puzzle: despite the S&P 500 being close to its record January high, stock market valuations are on the decline. Host J.R. Whalen and WSJ markets reporter Michael Wersthorne unpack the dynamics behind this paradox, focusing on the interplay between stock prices, rising corporate earnings, and sector trends.

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Key Discussion Points & Insights

1. The Current Market Situation

• Market Rebound: The S&P 500 is nearly back to its January record, but valuations (measured by metrics like P/E ratios) are lower.
• Valuation Squeeze:

  "A big part of the valuation squeeze that we're seeing currently right now has to do with just what the market did in January."
  — Michael Wersthorne (02:05)

Background Context

• January saw rapid market gains with valuations reaching high levels. Then, a sharp correction occurred in early February, compressing valuations.
• This compression has continued, despite prices rebounding, due to other underlying factors.

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2. The Key Role of Corporate Earnings

• Strong Earnings Growth:

  "So far this year [2018], corporate earnings have been phenomenal for companies. This is the third consecutive quarter where S&P 500 earnings have grown double digits from the year before."
  — Michael Wersthorne (02:51)

• Valuation Impact: Earnings have grown much faster than share prices, meaning that stocks, on a price-to-earnings basis, look cheaper ("valuations down").
• Noteworthy Statistic:
  • "24% year over year growth in profits" for the S&P 500 in Q2 2018 (03:27)
  • "Valuations now look better than they have since mid-2017" (03:36)
• For investors, this means stocks appear more attractively valued compared to recent history, despite the market's proximity to record highs.

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3. Sector Opportunities and Contrasts

Health Care and Financial Sectors:

• Undervalued Sectors:

  "At this point, there are some bargains to be had by investors, most notably in the health care and financial sectors."
  — J.R. Whalen (03:40)

• Financials Stand Out:

  "Financials is by far one of the cheapest, especially compared to some of the pricier corners of the market..."
  — Michael Wersthorne (04:07)

• Financials and healthcare stocks have been overlooked by investors amid broader market focus elsewhere, leading to lower valuations and possibly attractive buying opportunities.

Technology Sector:

• Tech as a ‘Safe Haven’:

  "Any sort of hiccup in the broader market has sent investors running to tech stocks, which has inflated their valuations."
  — J.R. Whalen (04:25)

• Defensive Asset Narrative:

  "Investors have just become very accustomed...they return to what's worked throughout this rally. And what's worked has been shares of technology companies."
  — Michael Wersthorne (04:37)

• Companies such as Microsoft and Alphabet have significantly contributed to market gains.

• Emerging Risks:

  "July was the first period we really saw in these companies financial results specifically, say Facebook, for instance, some of the early impact of data privacy law changes."
  — Michael Wersthorne (05:13)

• New regulatory and data privacy concerns (e.g., in Europe for Facebook) are causing investors to rethink the high valuations in tech, adding volatility and greater scrutiny.

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Notable Quotes & Memorable Moments

• On the Market Correction and Valuation Compression:

  "We moved from inflation concerns weighing on the market to now focusing on trade tensions. And in the middle of this, earnings has been playing in the backdrop."
  — Michael Wersthorne (02:38)

• On Investor Behavior:

  "Whenever there's any sort of fear or uncertainty in the market, they return to what's worked throughout this rally, and what's worked has been shares of technology companies."
  — Michael Wersthorne (04:39)

• On Sector Bargains:

  "If you look at financials compared to most other S&P 500 sectors...financials is by far one of the cheapest..."
  — Michael Wersthorne (04:07)

• On Tech Sector Uncertainty:

  "If I can't really price the kind of certainty I used to be able to price into share of Facebook rising 40, 50% in terms of profit growth every quarter, then I've got to take a step back."
  — Michael Wersthorne (05:23)

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Timestamps for Key Segments

• Economic & Market Overview: 00:26 – 02:05
• Why Valuations Are Lower: 02:05 – 03:40
• Sector-Specific Insights (Financials, Health Care, Technology): 03:40 – 05:43
• Regulatory Impact on Tech Stocks: 05:13 – 05:53

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Tone & Style

The tone is analytical yet accessible, with Michael Wersthorne providing clear, data-rich insights in a conversational style. J.R. Whalen guides the discussion with concise, pertinent questions, ensuring relevance for everyday investors.

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Summary Takeaway

Despite headline index gains, robust corporate earnings are making U.S. stocks look cheaper by valuation measures. This sets up selective opportunities, especially in underappreciated sectors like financials and health care, while caution is warranted in richly valued tech stocks facing new external risks. It's a nuanced market, meriting careful attention to both fundamentals and evolving sector dynamics.

Transcript

[Charles Schwab Podcast Host]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day, but what policy changes should investors be watching? Washington Wise is an original podcast from Charles Schwab that unpacks the stories making news in Washington right now and how they may affect your finances and portfolio. [e-mail] WashingtonWise

[J.R. Whalen]

your money briefing MONEY and market stories from the Wall street journal. I'm J.R. whalen in New York. The market is within shooting distance of matching its January high, yet valuations are trending lower. We'll unlock the mystery in a moment. First, these money headlines. The producer price index, which is essentially the prices that businesses receive for their goods and services, was flat in July from a month earlier when excluding food and energy categories, prices were up 0.1% in July from a prior month. But compared to a year ago, producer prices were up 3.3%. In disputes within U.S. trading partners, a fading boost from fiscal stimulus and rising short term interest rates are causing economists to revise their projections regarding US Economic growth. Now to be sure, consumer spending and business investment were strong in the spring as thanks in part to tax cuts that put more money in people's pockets and gave businesses a higher after tax return on their investments. But many economists say beyond a year from now, they see rising chances of signals emerging that point toward recession. This is your Money briefing from the Wall Street Journal. Welcome back, everybody. The markets are rising. In fact, the s and P500 is about half a percent within its January high, but valuations are being held in check. To help us understand why, Wall Street Journal markets reporter Michael Wersthorne is here with us to discuss. So Michael, amid all the volatility back in February, we thought valuations were low then, they're even lower now. What's helping to push them in a downward direction?

[Michael Wersthorne]

A big part of the valuation squeeze that we're seeing currently right now has to do with just what the market did in January. The market rose so much so fast, valuations just were sky high. And that all changed pretty quickly over the course of six, seven days. As we got from January to February, market fell into correction territory and you saw those valuations really get compressed. What's changed now is that that's all just continued throughout the rest of this year. We've moved from inflation concerns weighing on the market to now focusing on trade tensions. And in the middle of this, earnings has been playing in the backdrop.

[J.R. Whalen]

Yeah, you're right in your story that corporate earnings are giving stocks the appearance of being less Pricey corporate earnings so

[Michael Wersthorne]

far this year have been phenomenal for companies. This is the third consecutive quarter where S&P 500 earnings have grown double digits from the year before. What that's done basically is because stock prices haven't really moved all that much. We're now just less than a percentage point away from that record high we last hit in January for the S&P 500. Amid that stagnation amongst prices we're seeing earnings have just been phenomenal. What that's done is just sort of when you're looking at valuations over the last 12 month period, those really great earnings are getting factored in, pulling those valuations down even more. Now that we're into the second quarter, we're fully through that second quarter earnings period, 24% year over year growth in profits. Phenomenal for the S&P 500. A lot of investors are really happy. Valuations now look better than they have since mid-2017.

[J.R. Whalen]

At this point, there are some bargains to be had by investors, most notably in the health care and financial sectors.

[Michael Wersthorne]

That's where we've seen not a lot of attention in the stock market much of this year. Financials had been doing well soon after Donald Trump's election, but after that they've really petered out this year as we think about how inflation and interest rates are going to affect all those things. You've seen the valuation compression that was just mentioning earlier really happen within the financial space, within healthcare. If you look at financials compared to most other S&P 500 sectors, the other 10 financials is by far one of the cheapest, especially compared to some of the pricier corners of the market that are trading multiples well above the S&P 500.

[J.R. Whalen]

What's interesting is that any sort of hiccup in the broader market has sent investors running to tech stocks, which has inflated their valuations.

[Michael Wersthorne]

That's where you've seen this discussion happen in the marketplace as to whether or not tech stocks are this defensive asset, similar to the way an investor looks at gold or utilities or real estate. Investors have just become very accustomed. Whenever there's any sort of fear or uncertainty in the market, they return to what's worked throughout this rally. And what's worked has been shares of technology companies. I think a big part of that is if you look at Microsoft, Alphabet, both those companies are huge contributors to the S&P 500's gain this year.

[J.R. Whalen]

But at the same time, there's some external factors affecting that sector that has some money managers advising some of their clients to tap the brakes.

[Michael Wersthorne]

July was the first period we really saw in these companies financial results specifically, say Facebook, for instance, some of the early impact of data privacy law changes. Facebook, for instance, their user growth in Europe and revenue overseas was not as good as it needed to be. A lot of that was because they were getting a sense of how this changing regulatory environment is actually going to affect their operations. You've seen investors then look at the whole sector and say, if I can't really price the kind of certainty I used to be able to price into share of Facebook rising 40, 50% in terms of profit growth every quarter, then I've got to take a step back. You've seen this greater scrutiny then get applied to the entire tech sector where investors are really rethinking these really strong valuations throughout the whole space.

[J.R. Whalen]

Good reason to keep an eye on the markets and the market coverage. @WSJ.com that is Wall Street Journal markets reporter Michael Wersthorne joining us here in our studio. Michael, thanks for being with us.

[Michael Wersthorne]

Thank you.

[J.R. Whalen]

And that's your money briefing. I'm JR Whalen in New York for the Wall Street Journal.

[Charles Schwab Podcast Host]

This episode is brought to you by Charles Schwab. Decisions made in Washington can affect your portfolio every day. Washington Wise from Charles Schwab is an original podcast that unpacks the stories making news in Washington. Listen @schwab.com washingtonwise.