Market Insights: S&P 500 Valuation Update

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Macroeconomic and Market Developments:

• North American markets were down strongly this week. In Canada, the S&P/TSX Composite Index was down 2.48%. In the U.S., the Dow Jones Industrial Average was declined 4.58% and the S&P 500 Index fell 5.05% this week.
• The Canadian dollar was also down this week, closing at 78.26 cents vs 79.41 cents last Friday.
• Oil prices were fairly steady this week. U.S. West Texas crude closed at $120.44 vs $120.31 USD last Friday, and the Western Canadian Select price closed at $101.62 vs $99.53 last Friday.
• The gold price was up this week, closing at $1,871 vs $1,851 USD last Friday.
• Standard & Poor’s announced changes to the S&P/TSX Composite index starting June 20, 2022. Additions to the index are Athabasca Oil (ATH), Definity Financial Corporation (DFY), Filo Mining (FIL), Precision Drilling (PD), Pason Systems (PSI), and Spartan Delta (SDE). Deletions from the index are Cascades (CAS), Docebo (DCBO), Hut 8 Mining (HUT), Lion Electric (LEV), Martinrea International (MRE), and WELL Health Technologies (WELL).
• Canada's economy continues to generate a trade surplus. In April, the trade surplus narrowed to $1.5 billion and March’s surplus was revised downwards to $2.3 billion. Also good news for Canada’s economy, the Ivey Purchasing Managers Index (PMI) registered 72.0 in May, up from 66.3 in April (levels above 50 signal growth).
• The World Bank cut its forecast for global economic expansion in 2022 to 2.9%, from a January prediction of 4.1% and April’s 3.2% estimate. The bank said that this is due to a surge in energy and food prices, supply disruptions triggered by Russia’s invasion of Ukraine and an effort by central banks globally to increase interest rates to combat inflation.
• Nutrien Ltd. (NTR) announced that it plans to increase fertilizer production capability in response to structural changes in global energy, agriculture and fertilizer markets. The company also is planning to repurchase an additional $2 billion of shares, for a total of approximately $4 billion of repurchases in 2022.
• U.S. inflation accelerated further in May, with the Consumer Price Index rising 8.6% year-over-year vs the expected 8.3%. Core CPI, which excludes volatile food and energy prices, was up 6.0%, slightly higher than the 5.9% estimated. This news sent U.S. bond yields higher, with the 2, 5 and 10 year bond yields now all firmly over 3%.
• The Canadian economy added 39,800 jobs in May, surpassing the 27,500 gain anticipated by economists, according to Statistics Canada. Canada’s unemployment rate fell to 5.1%, the lowest recorded level going back to 1976. In a further positive sign, full-time employment jumped by 135,400, with part-time jobs down 95,800.
• Here is a link to a short video from Canaccord’s chief U.S. Strategist Tony Dwyer entitled A Sober Assessment of the Opportunity and Risk: DWYER VLOG

Weekly Diversion:

Check out this video of a guy rescuing a cat that turns into an cat ambush.

Chart of the Week:

Markets continue to be mired in a volatile trading range with a downward bias. Peak inflation appears to be pushed back a month or two primarily due to escalating energy prices, and this continues to be an overhang for markets which are attempting to forecast how this, and rising lending rates, will affect economic growth and forward-looking earnings. The tightening of financial conditions is affecting the availability of money, a key driver of economic growth and corporate earnings growth.

However, this tightening is being balanced against a strong labour market (the U.S. May labour report came out this week) that continues to show that the U.S. economy is growing. In addition, U.S. household balance sheets remain very strong and cash flow is healthy, which should help weather the storm as the U.S. economy transitions post-Covid away from goods and back towards services which is the largest part of their economy. The U.S. financial obligations ratio finished 2021 at 14.0% (this is the share of U.S. consumers' after-tax incomes that they need to use on debt obligations (like mortgage payments and car loans) as well as recurring payments such as property taxes, homeowners' insurance, and car lease payments). To put that in perspective, from 1980 (when the data starts) to the end of 2019, the ratio was never lower than 14.7%. Meanwhile, U.S. household net worth finished last year at more than eight times annual after-tax income, the highest ratio on record. Americans had $1.2 trillion in chequing deposits and currency before COVID and at the end of 2021 they had $4.1 trillion. Taking all this into consideration, we continue to see potential for a short-term rally this summer.
This week, we wanted to update where valuations are for the largest companies in the U.S. (courtesy of JP Morgan) to show how far equity valuations have come back in line due to the recent correction. This will provide some context in illustrating that markets are now positioned with more promising forward-looking returns. As you can see, the forward-looking price/earnings multiple on the S&P 500 has come back down close to the 25-year average, far from the loftier valuations witnessed in late 2020, although not as low as the COVID low. Even though central bank overnight rates are climbing and expected to climb further over the coming months, conditions remain accommodative relative to longer-term history. We believe that the secular bull market that began in 2009 is still very much intact, and therefore the overall trend should continue with a slight upward bias on PE ratios. As a result, we anticipate valuations to now be more supportive going forward. However, active management of select companies with strong balance sheets, competitive advantages and pricing power, as well as those that have shown a consistent pattern of growing their dividends, will be much more important than recent past. Put simply: good quality fundamentals matter.

Source: Canaccord Genuity, JPMorgan

Sources: CNBC.com, Globe and Mail, Financial Post, Connected Wealth, BNN Bloomberg, Tony Dwyer, Canaccord Genuity, First Trust, Bespoke, JPMorgan