Investor Alert

Jan. 13, 2020, 1:36 p.m. EST

Would the Sharks Pay 25x for the $SPX

Jan 13, 2020 (Stock Traders Daily via COMTEX) -- The Stock market seems like it is going up every day, the little volatility there has been so far in 2020 was experienced in afterhours trading so normal investors didn't even see it, and traders think it is 2017 all over again. There are material similarities between 2020 and 2017, so let’s take a look at the important ones, and what could be the most material difference too.

Should we be partying like it was 2017?

In 2017 the market moved higher consistently with very little volatility, institutional investors piggybacked on the ECB, who was buying about $60 billion euros per month of global assets, and the Price Earnings (PE) multiple on the stock market increased aggressively. The PE on the S&P 500 ended the year close to 25x, and experienced a multiple expansion of about 5.6% (from 2016). S&P 500 ETF (PSE:SPY) .

With multiples hovering around 25x as the year began, calendar 2018 brought surprising volatility, the markets declined, and the multiples fell modestly. One coincidence is that the PE on the Market as 2020 begins is again near 25x, like it was in 2017-2018, and that raises questions.

Maybe 25x is the bottom of a resistance range for valuation; there is always a point where things are too expensive of course, and 25x might be the beginning of that range.

Would the Sharks on Shark Tank pay 25x earnings for a company?

Where a prudent investor might consider valuation before making a decision, there is one source of asset demand that doesn’t care about valuation at all. That is, the ECB. The ECB is engaged in a regimented bond buying program, like they were back in 2017, and they are going to do it no matter how expensive things get, or how high the PE multiple becomes.

This is almost like it was in 2017, except the ECB is only buying $30B Euros per month this time, half of what they were in 2017. So far that seems like a non-issue though; institutional investors remember how they piggybacked the ECB in 2017, and it was easy to get back on the bandwagon.

That leads us to the material difference between 2020 and 2017.

The Material difference is that the PE is already near 25x as 2020 begins, where that high of a multiple wasn’t seen until the end of 2017. The buying pressure by the ECB is half of what it was, but the combined influence with piggybacking is basically the same. This tells us the multiple can get higher, and the market can see a multiple expansion similar to 2017 again, so long as these catalysts remain.

Once the catalysts change though, and we expect it to happen soon, the market will likely have a PE that is higher than 25x, valuation concerns could be more intense, and the stock market could run the risk of becoming more like 2018 instead.

So far it is 2017 all over again, but we need to monitor the Central Banks closely.

For a more detailed description of the catalysts referenced above please visit Stock Traders Daily.


Link to MarketWatch's Slice.