May 21, 2015 | Post by: Roman Chuyan, CFA Comments Off on Is The Stock Market Overvalued?

Is The Stock Market Overvalued?

Q1-2015 earnings for the S&P 500 companies ended up flat YoY. Flat earnings are nothing to be excited about, but the extent to which earnings exceeded earlier expectations, 4.9%, was impressive, and a wider margin than the historical average of 3% to 4%.

As was widely expected, the Energy sector is primarily responsible for the decline in earnings, with over-50% YoY decline in earnings for the sector. Looking forward, the consensus estimate for Q2 is now for a 4.3% YoY decline in earnings, according to Factset. Energy is driving the decline again, so Q2 reporting might develop similarly to Q1, where reported earnings might end up flat.

Despite flat Q1 and expected Q2 EPS, U.S. equities resumed their climb, with the S&P 500 index rising to a new all-time high. This increased the TTM P/E Ratio to 19.0 from 18.7 on Apr 30. So, yes, equities are “overvalued.” The more important question for tactical management, however, is by how much, and what it means for expected return on equities in the near term. According to our statistical forecasting model, equity valuation alone has a double-digit negative effect on expected return, i.e., we would expect the S&P 500 do decline by more than 10% if this was the only factor. However, there are other factors at play which more than offset the negative valuation, and result in total expected return for U.S. equities that is quite strong.

Confusing enough? Please review the following pages for more information on Model Capital’s approach to tactical investment management and our tactical SMA strategies. Model Capital Management LLC is a tactical investment manager.

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