Will 2018 Be A Year Of 'P/E Contraction'?

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by: Brian Gilmartin, CFA

Suddenly, all the prognosticators are bullish.

Individual investor sentiment had risen the last few weeks: Bespoke put out its graph today on investor sentiment:

Here is the data:

Actual dollar EPS

S&P 500

S&P 500

Y/Y gro

Total return

Calendar '19 (est)

$160.81

10%

Calendar '18 (est)

$146.24

11%

calendar 2017 (est)

$131.47

11%

20.0%

2016- actual

$118.10

1%

12.5%

2015 - actual

$117.46

-1%

1.380%

2014 - actual

$118.78

8%

13.69%

2013 - actual

$109.68

6%

32.40%

2012 - actual

$103.80

6%

16.00%

2011 - actual

$97.82

15%

2.11%

2010 - actual

$85.28

40%

15.06%

Source: Morningstar Stocks, Bonds, Bills and Inflation (except earnings data which is from Thomson Reuters I/B/E/S)

Analysis/conclusion: Just thinking out loud about 2018 and the one thing that jumped out this past weekend is that we haven't seen a year of P.E contraction since 2011. (Look at the table, and compare earnings growth vs. S&P 500 return for 2010 and 2011.)

That is a stretch of 7 years.

Looking back at the 1982-1990 bull market (and Thomson earnings data starts in 1985 on my spreadsheet), there were just 4 years where we saw "P.E contraction" in the 18-year bull market, and that was 1989, 1993, 1994, and 1995.

1993 was the final year of the RTC corporation, and the bank bailout after the commercial mortgage and real estate crisis of the late 1980s and early 1990s.

1994 was the 6 rate increases by Greenspan which shut down the market even though S&P 500 earnings grew 20%.

What shocks me is that in 1995, for those who remember the 36% return on the S&P 500, and the start of the Tech and large-cap growth phase - S&P 500 earnings grew a whopping 40% that year. (I did not know that until looking closely at the data tonight.)

Just navel-gazing before this weekend.

Usually, P.E contraction occurs when the Fed's active (however, 1994 was a huge surprise for the market - Greenspan shocked everybody that year), or some other "extreme" aspect to the capital markets happens.

We only know when something is a surprise when it happens.

More this weekend.

Thanks for reading…