Morning Brief: The stock market is entering a new phase

Myles Udland, Julie Hyman, and Brian Sozzi break down the outlook on earnings growth for the market amend economic recovery.

Video transcript

JULIE HYMAN: We are looking at valuations and whether we are going to see some PE compression as the year goes on. You know, this is really a question that has been persistent not necessarily throughout the pandemic, but as we have really started to see the rally in stocks. The recovery in stocks continue to persist and get ever higher. And that is, how much are people willing to pay for stocks, how high is too high, and are we going to continue to see PEs at the elevated levels that we have seen? And those are questions that you try to address in today's Morning Brief, Myles, using perspective from a number of the different strategists out there.

MYLES UDLAND: Yeah, I mean, look, I think readers of the Morning Brief know that from time to time, we can get a little bit in the weeds. And I almost felt bad writing today's version because I'm really encroaching on Sam Rowe's territory. Sam loves writing about valuations. Of course, Sam is a CFA charter holder. So he actually knows what he's talking about, where I just pretend to know what I'm talking about. But to your point, Julie, a number of strategists, and just within the last half hour, Sam sending me a note from Credit Suisse on the same subject. So now we've got no fewer than four Wall Street houses talking about the idea of the multiple for the market compressing.

And as you alluded to, what it basically means is, how much are you willing to spend for each dollar of earnings power? Right now, the forward PE on the S&P, based on FactSet's estimates of what 2021 earnings per share for the index will be is about 22. So every $22 you put into the market, you're expecting to get a dollar of earnings power back. Strategists think that that number is going to come down as we get into the second half of this year and certainly into next year.

Some folks, you know, UBS's Keith Parker, he's talking about a 19 multiple, Mike Wilson over at Morgan Stanley looking at basically about 20. But Mike's forward period for earnings, he was looking at second half of '22 and first half of '23 to get to the multiple for where the market trades in June of 2022. Lots of follow there-- don't worry about the details. The point is, this chart we're showing shows you that as the market has gone up in price, as the index level for the S&P has increased, the amount that investors are paying for the index has not. The reason why is that corporate earnings have been rising.

And this premium, this trailing 12 months PE, forward 12 months PE, however you want to do it, this premium is likely to decline, Brian Sozzi, as we go through the year. And I know this note really got you fired up as a former analyst. But look, it's the ultimate question for any stock in any index at any time. How much are people willing to pay for the future cash flows, again, of a business or a collection of businesses?

BRIAN SOZZI: Brought a tear to my eye, Myles. You and Sam always, always impress me in the Morning Brief newsletter, the award-winning Morning Brief newsletter. But here's a fun fact for you. Macy shares trade at 24 times forward earnings. So Myles, in essence, the market is expecting Macy's to grow faster than the market this year, just in terms of earnings or cash flow growth. And judging by the first quarter, maybe that's true or maybe it's not. But that's what the market's saying here today.

MYLES UDLAND: You know, Sozzi, that is a great point to say on a relative basis. And I know, again, like portfolio construction and how you build an entire allocation process, it's kind of beyond the bounds. We're a daily news show. We're talking about the latest earnings, the latest this, latest that. But when we talk about things like the washout we've seen in SPACs, the washout that we've seen in some of these hot SaaS plays, we are talking about relative valuation. That sector was valued on a multiple of sales. It could have been 10, 15, 20 times.

And every business, as you mentioned kind of with Macy's, Sozz, every business either trades in line, above, or below the entire group's multiple. And when investors decide, as they have with a lot of these buzzy names, that all of them deserve a lower multiple, all the stocks go down. And then they all go down in the proportion to how they're viewed relative to the benchmark. And so, again, it's all about this kind of second derivative sort of view on how you create a structure here, Sozz. But it is the heart of every question for every stock at any point in time.

BRIAN SOZZI: Well, I'll really have some fun with this. On a trailing price to sales ratio basis, Myles, Macy's shares traded 3/10-- 3/10. So it's telling you most of the recovery in Macy's earnings this year will be driven by the fact they cut billions in dollars in expenses. And there's not a lot of confidence that the company could sustain the type of sales growth it saw in the first quarter. Juie, over to you.

JULIE HYMAN: I mean, the only comment I was going to make about all of this is that, you know, all of these numbers are very important for the Brian Sozzis of the world and the Mike Wilsons of the world, but they're probably not important to the Wall Street Bets people of the world, or at least, not in the same-- to the same degree, right? I mean, even though Warren Kenny's out there doing fundamental analysis in 2020 on the likes of GameStop, I would venture a guess that many of the folks following, chasing the SPACs and crypto, as we know, how to even value that. So, you know, the PE question is a longer term fundamental analysis question that, as we have found out, is not always a relevant one in today's market.

MYLES UDLAND: But it always matters in the end, though. And so, maybe you got into this market and maybe you didn't know. And maybe you're buying things because Warren Kenny, whatever. But it does matter in the end, and people are going to learn that. And I think that just the way by which people learn these basic tenets of investing, we can debate which ones are good, bad, indifferent. But they are going to understand that this is sort of where things come back to. And I think everybody-- ultimately, I think just about everybody appreciates any time they have a learning experience in any given venture that they pick up for the first time.

JULIE HYMAN: Unless they lose too much money.

MYLES UDLAND: Unless they lose too much money. But look, if you lose a lot of money and then you figure out how you handled it, I think you learn something about yourself as well.