P/S ratios are really only relevant if compared with profit margin trends. One dollar of sales generating 5% profits is worth more than one dollar generating 2%. The mother of all bubbles was in the late 1990s when P/S went trough the roof, and more, while profit margins were collapsing. The more recent inflation in the P/S ratio has been supported by sharply rising margins through 2011. However, the drop in oil prices cut margins by nearly 30% in 2014-15. The recent recovery brought margins back to the low end of their range since 2005, but still 15% below their 2012 peak.
The S&P 500 Index lost 15% in 2015 from peak to trough but the Trump Rally erased all this as investors quickly discounted the impact this Administration said it would have on the economy, after tax margins and profits. The Rule of 20 barometer illustrates the Trump impact: valuations jumped even though the Fair Value Index (yellow line below) remains weak and trending lower as inflation has been accelerating faster than profits.
Similar divergences occurred in 2007, in 1998-99, in 1987, in 1979-80, in 1970 and in 1962. Just so you know…
We all know something not funny will eventually happen. Eventually, like after an event, or a lack of expected events… For now, we’re into the first innings of the Q1 earnings season, but it’s getting gradually late for health care, tax reform, infrastructure. etc…We now have to worry about the unknown knowns .
A TRAMP ABROAD
Given the now widely accepted overvaluation of U.S. equity markets, your friendly broker will surely tease you with this chart:
Looking at this chart, it is very tempting to shun the US and move money abroad.
Oups! Mind the European gap!
Mean reversion? Well, sir, it’s been 7 years now.
FYI, sir, Thomson Reuters sees the STOXX 600 EPS up 7.8% in Q1 vs +10.0% for the S&P 500. How much longer before the reversion please?
Also, sir, should we care about: Brexit? France? Italy? Greece? Merkel? Russia?
Emerging markets? Maybe…but, sir, look at this interesting correlation courtesy of Ed Yardeni:
Sir, any solid forecast on where commodity prices are heading to? Can this help?
Any sign of mean reversion up there?
Still comfortable with emerging markets now, sir?
Mean reversion? Careful, sometimes the expected reversion can be pretty mean…
Here’s what I wrote in Feb. 2015: Don’t Be A Jerk!