Stocks have staged a strong recovery in January, rallying sharply off the lows made during the December sell-off. One possible driver of the recovery could be tied to the margin of safety stock valuations offered after the fourth-quarter rout. In other words, markets may have overreacted to a litany of concerns.
In the accompanying graphic, we examine how much bad news was priced into the market at year-end. The right side of the graphic shows the average price-to-earnings (P/E) multiple for the S&P 500 since 2008 and over the last 25 years, as well as when the yield on the 10-year US Treasury was below 5%. The left side shows the S&P’s forward P/E at the end of December, assuming either 0% or 8% earnings growth.
The conclusion one could draw is that the market was assuming 0% EPS growth for S&P 500 companies in 2019, since the P/E using that assumption (15.5x) was in line with long-term averages. And yet, that assumption is likely too dire, and investors may have recognized that, which led to the January rally.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.