On August 13, 2014, Barclay's chief equity strategist Jonathan Glionna stated the following:
"We believe U.S. equities are transitioning out of a recovery rally and into a period of lower returns as the benefits of margin expansion and sharerepurchases prove to be already priced in and a return of faster revenue growth becomes prerequisite for another re-rating higher."
However, in the interview with Bloomberg, Wells Fargo Chief Equity Strategist John Manley disagreed with Barclay's view. His point is that the market "has not gone crazy yet," and it is too early to end the party. He believes that, compared to the markets prior to the dot-com bubble in 2000 and the oil crash in 1979, the current market with a forward PE ratio of between 15 and 16 is not too high and can move higher.
He believes another reason for the rally is that an increase in the capital expenditure (Cap Ex) has not happened yet but will kick in soon, which will boost growth.
Nevertheless, his reasons are fallacious. First, the current forward PE ratio of 16.25 (an increase from 15.7 in July) is already high. In fact, it is above the five-year average of 13.3, ten-year average of 13.8, and fifteen-year average of 15.8.
Moreover, the current forward PE ratio is significantly higher than it was prior to the 2008 crash. It is true that the current ratio is not as high as it was prior to the dot-com bubble crash. However, the dot-com bubble is too extreme of a case and should be considered as an outlier-an event that most likely will not repeat. Along with the market price, the PE ratio has been rising at a rapid rate for more than three years. It is not too early to end the party; it already has been going for too long.
Also, the expectation that Cap Ex will increase is wrong. Due to extensive Quantitative Easing (QE), the long-term interest rates has been extremely low for an extended period. With the cheap money, corporations were paying dividends and doing share-buyback programs, as shown in the chart below.
If the corporations were confident about their businesses and saw opportunities for growth, they would rather spend the cheap money on Cap Ex. However, they did not do so, and the QE is terminating in October. It is difficult to believe that corporations will increase Cap Ex when interest rates increase when they did not do so when interest rates were low.
Conversely, Barclay's claims sound reasonable. In the last few years, the share-buyback programs, supported by low interest rates, have boosted stock prices. Since 2010 the S&P 500 (NYSEARCA:SPY) increased 77%, the Dow Jones (NYSEARCA:DIA) increased 61%, and the Nasdaq (NASDAQ:QQQ) increased 99%. However, with the end of the QE, the share buybacks will shrink as the interest rates climb. As the share buybacks disappear, sales and earnings will need to increase significantly to support the stock prices. However, there is not much sign of significant increase in growth, especially with the current slowdown in Europe's economy.
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