EC Don't Look Now But Valuations Are Improving

There is a situation developing in the macro picture that I thought warranted a quick note. As you are likely aware, one of the bear camp's major arguments is that stock market valuations are scary-high right now. And since we are likely seeing "peak everything" here, our furry friends suggest that there is only one way for stock prices to go from here - down.

I've written about valuations several times already this year, with the latest missive dated July 6, entitled "Why I'm Not Worried About Valuations".

My primary point was that the stock market's P/E ratio tends to rise - oftentimes dramatically so - as the country begins to exit a recession. The reason is simple math. Since the market is "a discounting mechanism of future expectations," stocks tend to rally at the depths of a recession as traders begin to discount better days ahead. This occurs while the "E" in P/E continues to fall as a result of the economic slowdown. Thus, with "P" going up and "E" going down, you get elevated P/E ratios.

Typically, what happens next is earnings rebound as the recession ends and economic growth resumes. And as the economy normalizes after the interruption, the P/E Ratio does too. In short, this is why I'm not overly concerned about valuations at this point.

Yes, there are times such as 2000-2002 where sky-high valuations have been a problem. In this case, the popping of the tech bubble created the recession. Not the other way around. Prior to the tech trade unwinding, the economy had been just fine.

Granted, this cycle was completely different than anything we've seen in the past because the economy had never before been intentionally shut down and then reopened due to a pandemic. But my take is that the current situation is the opposite of what we saw in 2000 and more in line with the way valuations tend to act after recessions.

The "E" is Definitely Improving

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should ...

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