Chart of the week: Wall street moves from 'perfection' to 'correction'

1 November 2018

Bob Cunneen, Senior Economist and Portfolio Specialist

                  Forward Price to Earnings Ratio 1 year


Source: FactSet and Institutional Brokers’ Estimate System (IBES)

Wall Street’s golden run in terms of a rising share market seems to have come to an end in recent weeks. After reaching a historic peak of 2,931 in September, the benchmark S&P 500 index has fallen nearly 10%. There is a ‘check list’ of concerns that has driven Wall Street’s sharp reversal in October such as higher US bond yields, the escalating trade war between the US and China, Emerging Market stress, Italy’s contentious budget stimulus proposals as well as greater global regulatory scrutiny and taxation of technology companies.

However one key reason for this sharp selloff is that US shares were priced for perfection and vulnerable to any disappointment. US shares had a very high Forward Price to Earnings (P/E) ratio of 17 in September (blue line). Even with expectations that US profits would increase a further 10% in 2019 after the 20% forecast growth for this year, the S&P 500 was ambitiously priced for the ‘best of all possible worlds’. Arguably US shares have come back to reality with October’s price slide. The US Forward P/E was 15.5 as at 26 October according to FactSet and is now much closer to the past decade’s average of 14.5.

For all global share markets, there is nowhere to hide when Wall Street finds reverse gear. Even Australia with a more moderately priced Forward P/E has also suffered in October (red line). Global investors will probably need to see a convincing armistice for the trade war and more stable US bond yields before again pricing Wall Street for perfection.

 Source : Nab assetmanagement November 2018 

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