The Good News: Valuations Are Improving

As the title of this morning's missive indicates, there is some good news to report to start the week.

To be sure, the mood on Wall Street has soured lately. Instead of looking ahead to all the good stuff that is likely to occur in the next calendar year and enjoying the traditional year-end rally (aka the Santa Claus rally), traders are focused on the negative. And while things can certainly change in the markets, this has been the worst start to a December since... wait for it... 2008. Argh.

With all the talk about slowing global growth (lest we forget, Germany, Japan, and Switzerland all reported negative GDP results last quarter), slowing earnings, slowing job growth, the trade war, the political risks, peak iPhone, higher rates, the Fed, slower home sales, another big drop in oil, the end of the buy-the-dip era, and of course, when the next recession/crisis will hit the U.S., it is easy to see the market's glass as half-empty here.

However, there is some good news to consider. Valuations have definitely improved.

No, stocks are not cheap. But on a price-to-earnings basis, I'll argue that stocks are no longer extremely overvalued either. And from a macro perspective, this is indeed a good thing.

To be clear, P/E Ratios are not the only way to measure market valuation. And by other measures, such as Price-to-Sales, stocks remain at nosebleed levels. However, the granddaddy of valuation metrics, the Price-to-Earnings ratio, has been getting better.

If you think about what has transpired over the past year or so, this makes sense. The "P" (Price) in the P/E Ratio has gone almost nowhere in 2018. Yet, at the same time, the "E" (Earnings) has soared. As such, it shouldn't be surprising to see the P/E moving down.

For example, below is one of my favorite versions of the P/E ratio. Instead of using the entire S&P 500, this approach uses the P/E of the median stock. I.E. The midsection of the market. Half above and half below. Take a look at the chart below:

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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

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