The Wall

By David Nelson, CFA

Most of the metrics for the current economic outlook have been everything we hoped for. Consumer Confidence, housing and even Friday’s durable goods orders were strong on the heels of strong aircraft sales. By some measures, CAPEX or capital expenditures are finally making it into the mix. Bloomberg points to early signs of companies finally moving beyond the financial engineering of buybacks and making capital spending a priority.

Capex growth for companies that have reported (%, Y/Y) – Bloomberg

Despite the above, markets are struggling to meaningfully break out of their post correction slump. The good news is that the S&P 500 is living above the 200-day moving average which still has a positive slope. Add the fact that the (VIX) Chicago Board Option’s Exchange SPX Volatility Index is back near 15 creates a good setup for the markets in the days and weeks ahead.

Strategists, analysts and portfolio managers are always looking for a metric or catalyst that explains the current state of the markets and maybe help illuminate the path ahead.

The truth is, it’s always something different but here’s what’s on my radar right now. Valuation is in the eyes of the beholder. For some, growth justifies any price and that’s certainly evident in market favorites like Amazon (AMZN), Netflix (NFLX) and an entire wave of companies with a secular growth story to support the shares. Others might focus on more traditional value measures like PE (Price/Earnings) ratios and still others might look at Enterprise Value which includes debt / EBITDA (Earnings before interest, taxes, depreciation & amortization)

The chart above paints an interesting picture taking us back to the heady days of the internet bubble through 2 bear markets including a financial crisis ending with last week. Apart from the months leading into the tech collapse in 2000 where PE ratios defied gravity, many traditional valuation metrics all reached levels in January that have given investors pause at several key moments in history.

Putting it all together it seems we will need even stronger data to help drive up prices in the broad indices. Admittedly nothing lowers multiples quicker than stock prices but it’s important to look outside the box. While the broad market is getting rich there are any number of sectors and securities that are ripe for higher prices. I’ve often mentioned financials a sector with a cyclical tailwind of rising rates but even in technology there are stocks trading at below market multiples with strong secular growth ahead. All ammunition for the next article.