Equities

A Bull Market With Stretched Fundamentals

According to Yardeni Research, the S&P 500’s bottom-up earnings estimate for 2025 is $263.43. Should that come to pass, it would bring this year’s growth rate to a very achievable 7.0%.

The 2026 estimate is more of a stretch. The consensus is penciling in earnings of $300.09. That should be tough to come by because it would mean growth of nearly 14% next year. Still, FY2 earnings estimates are frequently sky-high; almost all serious strategists wink at each other on these things, then mentally revise down. If earnings come in around $280–$285 or so in 2026, that would be just fine for most observers.

Nevertheless, at face value, these figures put the market’s P/E multiple at 24.8x, 23.2x and 20.3x earnings for 2024, 2025 and 2026, respectively. At earnings of $280, the multiple is 21.8x.

Those valuations are what you get when the S&P 500’s V-shaped reversal from its April 8 lows sends the market up 23% in less than three months. Suddenly, the S&P 500 finds itself in its fourth go at the 6,100 level (it is trading at 6,103 as we write). The first attack on this territory came in early December as the market got excited about Trump’s election. It then took a routine breather before running back to current levels twice again in February. Now here we are again, with “Sell in May” having fizzled and a fourth onslaught of 6,100. The more this happens, the harder the cement grows on this level, be it support or resistance.

“The S&P 500’s V-shaped reversal from the April 8 lows sent the market up 23% in less than three months.”

We are observing a few promising developments that will be critical if the market is to support a valuation that is pushing nearly 25x last year’s earnings. We could end up eating crow on this, but it appears that almost everything we ever read, ruminated on and heard about Iran’s threats of closing the Strait of Hormuz went out the window in the last few weeks.

Whether the year was 1990, 2000, 2010 or 2020, we have all read our share of Hormuz Doom-mageddon think pieces, with seemingly every one of those putting $200 oil on the radar. Instead, what we really got out of this year’s Hormuz threat, the boldest on record, was Brent crude mustering a half-hearted rally. Additionally, the Energy sector itself couldn’t even take the leadership baton amid Israel’s bombing of Iran’s nuclear facilities. To wit, over the last month, the S&P 500 Energy sector has been ranked just 4th among the 11 sectors.

Right or wrong, and we are thinking “right,” the market is coming to a belief system that has Middle East wars having minimal effect on the vagaries of the stock market, at least prior to prior cycles. This is a far cry from the action in 1990, when Iraq went after Kuwait, sending stocks down. September 17, 2001, when markets first reopened after the terror attacks, also comes to mind. The Middle East simply moved markets more back then than it does now, largely due to the United States’ more secure oil supply/demand profile these days relative to the pre-shale era.

“The market is coming to a belief system that Mid East wars have minimal effect on stock market volatility— a stark contrast from previous decades.”

Meanwhile, prognostications of recession will have to wait. We are heartened by lending activity. For example, the YoY rate of growth in small bank loans bottomed in March at +2.8%. It ticked a tad higher in both April and May, to +3.3%. We saw similar action in this indicator in 1991, 2010 and 2021. The first two of those episodes preceded nine years each of heady stock market gains. Then again, the bears know well what happened to stocks in 2022 (the NASDAQ, to use the poster child, fell 30% top-to-bottom).

Something else is promising for stocks: our concerns about bond market ructions affecting order and continuity are gently dissipating, though the market is far from out of the woods. For example, we’ve long been bullish on Japan, but spring ushered in summer with that country’s bond market having a freak-out. It wasn’t that long ago, 2022 to be exact, when Japan’s 30-Year bond traded south of 1%. It first breached 2% in May 2024, then continued up to a high last month of 3.17%. It has since settled at 2.88%. Similarly, the U.S. long bond changed hands at as high as 5.1% this spring before stabilizing at 4.77%.

We continue to remain keen on Japan. The country’s “shareholder yield payout ratio,” which combines buybacks and dividends as a fraction of earnings, has risen to 61%. For context, MSCI China and the S&P 500 each have a shareholder yield payout ratio of just 40%. Broad Japan’s shareholder yield itself is 4.0%, akin to levels observed two months after Lehman failed and double the 2% on offer in the S&P 500. The gap between the two is the widest in our proprietary PATH software’s dataset, which dates to 2006.

Additionally, more than half of Japan’s large caps have an earnings yield that is at least 400 bps north of what is available on the 10-Year sovereign bond. In contrast, only about one in five S&P 500 names sport that type of margin of safety over U.S. T-notes.

China could be an interesting case, though we remain underweight to the country in our Model Portfolios. The country’s stock market came to life last autumn: MSCI China has outperformed the MSCI USA Index since September 13, 2024. We think that both China and Korea had a “What about me?” moment in 2023–2024. That’s when those two large economies both realized it was time to tag along with Japan on a push for corporate governance reform, which was the catalyst for the latter’s bull market in recent years. Those themes remain “on” in the second half.

As for Europe, we have reason to believe the direction of the euro’s exchange rate, currently $1.18, will be the primary driver of European equities in the second half. On that score, partly because bearish sentiment on the dollar is at multi-year extremes, we are dollar bulls.

To give you an idea of how lopsided things are, Bank of America’s June Fund Manager Survey found the percentage of respondents who say they are overweight to the dollar to be at the lowest level since January 2005. This result is corroborated by the heavily followed ZEW survey, which just posted its most bearish U.S. dollar response since the question was first posed in 2012. We do not believe the dollar’s status as global hegemon is going away anytime soon. Put us down for a USD relief rally this summer.