One Valuable Investing Lesson Wall Street Will Soon Be Forced to Remember

Stock valuations don’t matter until they do, sages on Wall Street often say. 

The old trading floor adage is playing out currently in the markets and it could end up badly for the wild-eye bulls. The S&P 500’s record on Thursday pushed the index’s forward price-to-earnings multiple to about 16.9 times. That puts the broad market index’s valuation 11% above its long-term average and relatively in line with the February high. 

Recall that the S&P 500 peaked around Jan. 29 in a market melt-up rooted in tax cut and Corporate America profit optimism (sort of like now). The S&P 500 proceeded to tank 10% from that peak to Feb. 8 as investors reassessed stock valuations. 

The argument could be made we are experiencing late January-like conditions in the markets.

Since the start of the third quarter, the S&P 500 has rocketed by 7.5% while the forward twelve-month profit estimate on the index has only increased by 2.8%, according to FactSet data. Seven sectors have forward twelve-month price-to-earnings ratios that are above their 10-year averages, led by the Information Technology (19.0 vs. 14.6) and Consumer Discretionary (21.6 vs. 17.0) sectors.

Meanwhile, investors are completely ignoring rising trade war tensions, profit warnings from bellwether names such as 3M (MMM) and FedEx (FDX) and the contentious mid-term elections. 

“Some will say that it’s because [investors ignoring trade war headlines] it only impacts a small part of the U.S. economy, but I also think that the positive impact of the tax cuts are enabling both business and consumer confidence to remain high. The problem is that the effects of those cuts will begin to wane next year just as the effects of the tariffs begins to have an impact,” cautions Miller Tabak strategist Matt Maley.

Memo to the bulls: dust off the investing textbooks. 

3M is a holding in Jim Cramer’s Action Alerts PLUS member club.

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