By Philip Lawlor, managing director, Global Markets Research
Propelled by the April relief rally, forward PE multiples have regained much of the ground lost in the global market meltdown in March. But with the drop in stock prices since the February peak outpacing the decline in underlying earnings forecasts—and the profit outlook still murky—this valuation re-rating appears to be on a shaky footing.
As the chart below shows, forward 12-month PE multiples are at or approaching some of their highest levels since January 2019. The rebounds from mid-March lows have been particularly sharp for the Russell 1000 (a gain of more than 400 basis points through April 17) and the FTSE Europe (up more than 300 basis points). At 18.3×, the Russell 1000 retains a hefty premium to its peer group, which have converged around an average PE of 12.7×.
Regional 12-month forward price/earnings multiples (×)
Source: FTSE Russell / Refinitiv. Data as of April 17, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
On a cyclically adjusted (moving-average) basis, however, PE ratios have continued to fall, with the Russell 1000 CAPE back near early 2016 levels of around 20x, after dropping below the recent Q4 2018 lows in March. It also remains significantly above those of developed peers, which have clustered around the 11-15x range.
Regional cyclically adjusted price/earnings multiples (×)
Source: FTSE Russell / Refinitiv. April 17, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
But, as the chart below illustrates, since the recent market peak of February 19, the forward PE shift has been driven by the sub-optimal circumstance of FTSE index levels (the "P") falling more steeply than the revisions to EPS forecasts (the "E"). We could well see the opposite dynamic occur—with the "E" falling at a faster pace than the "P"—in the coming weeks as the quarterly earnings season continues to unfold.
Changes in index levels and forward EPS forecasts since February 19, 2020
Source: FTSE Russell / Refinitiv. Data as of April 17, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
As we wrote in an earlier blog post, the year-long downtrend in forward earnings revisions took a sharp dive lower over the past month to some of the lowest levels of the past 10 years, albeit still a far distance from the extremes of the 2008-2009 recession. Given the bleak economic backdrop and still-unknown scale of the pandemic’s damage, this cycle of negative EPS revisions likely has some way to go. In this environment, forward PEs offer only a foggy reading of current market values.
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