Eye on the Market 2020
Comment of the Day

January 06 2020

Commentary by Eoin Treacy

Eye on the Market 2020

Thanks to a subscriber for this report from JPMorgan Asset Management which may be of interest. Here is a section:

Eoin Treacy's view

Here is a link to the full report and here is a section from it:

Another headwind for 2020: valuations are high, and we are starting to see cracks in risky and poorly underwritten investments.  Valuations have been on the high side for a while given easy central bank money, but there are signs that investors are starting to be more discerning about risk and cash flow fundamentals.  Example #1: energy.  Credit spreads for energy companies are widening even as overall high yield spreads don’t.  Furthermore, after a decade of energy sector underperformance vs the overall market, there has been a collapse in energy-related debt and equity issuance.   

There has also been a spike in “weakest link” companies, which refers to companies rated B- or worse with negative outlooks (below, left).  And as most investors are aware, some 2019 tech IPOs have been poor performers.  However, as we discuss on page 26, this is mostly the case with IPOs of companies claiming to be technology firms but which lack some of their critical attributes. 

US equity valuation measures: high vs history.   As shown in the table on the next page, most valuation measures are around the 90th percentile of historical expensiveness.  These measures crept up during 2019, since the double-digit equity rally in 2019 was based almost entirely on multiple expansion, in contrast to the 2009-2018 period when the US equity rally was driven primarily by earnings growth.  While we expect profits to rise modestly in 2020, gains may be limited due to rising labor, interest, depreciation and SG&A costs, all of which are trending higher relative to revenues.

Valuation expansion is one of the most commonly voiced concerns among investors looking at predicting what stock market returns are likely to be in 2020. They have a point. Earnings have not risen to nearly the same extent as prices and profits have been rangebound for nearly five years. However, it is also worth considering that much of the valuation expansion seen last year was an unwinding of the decline posted in 2018.

That suggests we are at the point where global reflation would be a welcome development to help justify historically high valuations. The good news is it's looking more likely than not as the trade war is no longer escalating. Meanwhile monetary and fiscal accommodation are running hot which is supportive of even higher valuations. 

The majority of global stock market indices have broken out. While there is short-term risk of consolidation the benefit of the doubt can continue to given to the upside provided the region of the 200-day MA continues to hold.

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