Narrative or Earnings

Wednesday, August 15th, 2018

Josh Brown had a comment on a WSJ article which talked about how, since 2011, you could have focused either on corporate earnings growth or the negative commentary around FED tapering. If you had focused on the FED narrative, you would have missed out on the massive 161 per cent rally in the S&P 500 which was led by strong corporate earnings growth and good fundamentals.

Unfortunately, the Indian markets have worked the other way. While the markets have rallied over the years, it has primarily been based on hopes of a pickup in growth and turnaround of our domestic economy. Every year we see analysts start the year with projections of EPS growth in the range of 20 to 25 per cent, only to inevitably be disappointed and revise them down to single digits. Today valuations are at an all time high and everyone is betting on an “inevitable” acceleration of earnings growth, with most analysts projecting EPS out two or three years to justify prices.

No doubt that there have been a number of structural changes in the economy which will lead to strong medium term growth, but the question is whether this is all priced in the markets already. Any disappointments could lead to further corrections.

Phillip Capital has a research report out with a number of charts on current valuation. I found this one in the Appendix to be quite interesting:

 

The earnings yield is at the lowest it has been in more than a decade. And the spread between earnings yield and the bond yield has widened almost to levels last seen in 2008. With greater concerns on the macro front due to rising global rates and currency tensions, it is unlikely that this spread will come down due to falling bond yields. If this spread is to come back to more normal levels, either stock prices have to come down or earnings have to accelerate more than the already elevated markets expectation. On a risk adjusted basis then, clearly bonds seem like a far more attractive prospect.


About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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