S&P 500 forward P/E versus forward EPS
Financial conditions, Fed liquidity, falling COVID cases can explain the re-rating
The S&P 500 forward P/E troughed at 13x and has risen to 19x, at year-to-date highs. Forward next twelve months (NTM) EPS on the other hand has fallen 11% since the March low and 15% since the February high. Thus, the 28.5% rally from the bottom looks fueled by a 46% jump in P/E. We use existing and new frameworks to assess what drove the P/E swings and respective sensitivities. With the P/E overshooting our implied P/E based on the drivers below, on the way down and up, a further re-rating higher near term looks unlikely with spreads repricing so much and UST issuance coming. A spike in new COVID cases is an asymmetric downside risk, while sustained lower cases could provide some support.
- Rates and spreads lower (1.2x or 9.2%). The fall in UST yields since the equity lows was a ~0.4x bump in the P/E in our model, with Fed actions helping to lower credit spreads a ~0.8x boost, and seemingly taking a worst-case outcome off the table.
- Fed B/S (1.2x or 9.5%). The $2tr surge in Fed buying since mid-March was worth ~1.2x for the P/E in our framework, net of UST issuance. The key then will be how much of the coming UST issuance will the Fed offset with continued buying.
- COVID new cases falling (1.1x or 8.4%). We regressed the level and 5d change in global new COVID cases against the S&P NTM P/E using natural logs since February. Flat-to-down new cases has been a 1.1x boost to the P/E. So a flare up would point to notable downside while a 1/3 decline in new cases as implied by search interest would point to just 0.25x upside. Thus, in our model, COVID cases are an asymmetric downside risk.
- Positioning/overshooting. Composite equity positioning was 2.5stdev below average at the market low and has risen to 1.1stdev below avg. With the backdrop still uncertain, exposure is unlikely to go above neutral near term. However, "normalization" in cases and thus activity could see eventual overweights with a new cycle and rates so low.