This Stock Market Can Be Awfully Deceiving

When the S&P 500 Index surged on Tuesday to its highest in five weeks, bringing its rally since bottoming on March 23 to 27%, the sense was that the market was signaling that the worst from the coronavirus pandemic would soon be over. On Wednesday, though, the benchmark took a hit, falling by more than 2% as data on U.S. retail sales and factory output for March posted historic declines. Other figures measuring economic activity for April also suggested a very deep recession is in play.

The recent rebound in equities had made stocks as expensive as they have been at any point during the past two decades based on one key measure: The S&P 500 was trading at about 20 times this year’s estimated earnings. Problem is, analysts have only started cutting their 2020 profit forecasts, dropping them to $141 a share on average for the index from $175 in early January, according to data compiled by Bloomberg. Those forecasts are likely to go far lower as companies report first-quarter results over the coming weeks and executives update their outlooks. It’s not hard to imagine investors questioning why they are paying so much for earnings that are likely to keep shrinking. During the 2008-2009 financial crisis, profit estimates came down by just over 30%. If we see the same thing happening now, which is a conservative estimate, then projections will drop to around $120 a share, implying a price-to-earnings ratio for the S&P 500 of about 23. “Even with $4 trillion of direct and indirect stimulus” from the Treasury Department and Federal Reserve, “the current level of the S&P — over 2,800 — is completely unjustifiable,” the strategists at Cantor Fitzgerald wrote in a Tuesday research note.