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De-rating exceeded rise in rates, late cycle discount
The S&P 500 NTM P/E fell toward 15x at the October lows, essentially pricing a 2015-16 type scenario. The P/E is now also over 1x below our model implied, and 2-3x below fair has been a point of support outside of recessions. The decline in the S&P 500 P/E since the start of the year is in excess of the headwind from the rise in rates based on our model (~0.5x) and the discount due to the jump in earnings to well above trend levels driven by tax (~1.4x).
Our P/E model does incorporate a cycle adjustment concept (similar to Shiller CAPE), whereby the market does not usually pay for above trend EPS. The beta is such that the multiple goes down by 1x for every 8% above trend that earnings go. We factored that into our outlook, but the de-rating this year has been far in excess of the move in rates and the typical discounting of later cycle earnings.
The difference between the actual P/E and our model implied level is ~1x, or 6%, which is in excess of our estimate of the growth hit from China tariffs on S&P EPS (~2%) while the USD and oil have yet to be an incremental headwind to earnings.
Figure 8: S&P 500 actual trailing P/E vs. Fitted P/E ex LTG
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Actual P/E - trailing |
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Fitted P/E (ex LTG) |
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22 |
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21 |
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20 |
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19 |
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18 |
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17 |
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16 |
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Jul-14 |
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Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 |
Jul-16 |
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Jan-17 Apr-17 Jul-17 Oct-17 |
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Jul-18 |
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Jan-14 |
Apr-14 |
Oct-14 |
Jan-15 |
Oct-16 |
Jan-18 |
Apr-18 |
Oct-18 |
Source: S&P, IBES, FactSet, Haver, UBS
The de-rating in the trailing S&P 500 P/E is in excess of what our model implies based on higher rates and other macro drivers.
Figure 9: S&P 500 EPS and the historic 6% trend |
Figure 10: S&P 500 EPS relative to trend |
6.0 |
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0.4 |
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Log EPS |
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EPS Trend Estimate |
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5.0 |
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0.3 |
4.0 |
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0.2 |
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0.1 |
3.0 |
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0 |
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2.0 |
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-0.1 |
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-0.2 |
1.0 |
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-0.3 |
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0.0 |
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-0.4 |
56 |
62 |
68 |
74 |
80 |
86 |
92 |
98 |
04 |
10 |
16 |
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Recession |
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Log EPS relative to trend |
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55 |
61 |
67 |
73 |
79 |
85 |
91 |
97 |
03 |
09 |
15 |
Source: S&P, FactSet, IBES, UBS |
Source: S&P, FactSet, IBES, UBS |
US Equity Strategy 13 November 2018 |
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