A Year-End Rally Could Double The S&P 500's Gain This Year
Audio Brief
Show transcript
This episode analyzes S&P 500 earnings, valuation metrics, and market seasonality with Datatrek Research.
There are four key takeaways from this discussion. S&P 500 earnings power remains robust, with margin expansion across multiple sectors. Historical valuation metrics like the Shiller P/E ratio may be less relevant today. Big Tech generates immense cash flows, funding growth and shareholder returns. Market history suggests a strong tendency for stocks to rally into year-end.
Corporate earnings have been surprisingly resilient and better than feared, supporting the market's rally. Profit margins are expanding across multiple sectors, not just technology, indicating broad-based strength beyond the largest companies.
The usefulness of the Shiller P/E ratio, currently at historically high levels, is questioned. Comparing today's S&P 500, dominated by high-margin tech giants, to the industrial-heavy index of the past may overstate how expensive the market truly is.
Despite massive capital expenditures on AI and infrastructure, the Magnificent Five generate even larger operating cash flows. This allows them to fund aggressive growth internally while still having ample cash for shareholder returns through buybacks and dividends.
Historical data shows the S&P 500 typically makes its high for the year in the fourth quarter, 71 percent of the time over the last four and a half decades. In such years, average annual returns are significantly positive, suggesting a high probability of a strong year-end finish.
These insights offer critical perspectives on current market dynamics and potential future trends.
Episode Overview
- Josh Brown welcomes back Nick Colas and Jessica Rabe from Datatrek Research to discuss the current state of the market.
- The episode analyzes the S&P 500 earnings season, highlighting strong performance and better-than-feared results, which justifies some of the market's recent rally.
- They break down long-term valuation metrics like the Shiller P/E ratio, questioning its relevance today given the structural changes in the market and the dominance of highly profitable tech companies.
- The discussion covers market seasonality, noting the historical tendency for the S&P 500 to peak in the fourth quarter, and examines the cash flow and capital allocation strategies of Big Tech.
Key Concepts
- S&P 500 Earnings Power: Corporate earnings have been surprisingly resilient. The discussion explores the magnitude of earnings beats, noting that while not as high as the post-COVID surge in 2021, they are still strong and improving. Profit margins are expanding across multiple sectors, not just technology, indicating broad-based strength.
- Valuation and the Shiller P/E: The hosts debate the usefulness of the Shiller P/E (CAPE) ratio, which is currently at historically high levels. They argue that comparing today's S&P 500, dominated by high-margin, capital-light tech giants, to the industrial-heavy index of the past is an apples-to-oranges comparison that may overstate how expensive the market truly is.
- Big Tech Capital Allocation: A detailed analysis of the "Magnificent 5" (excluding Apple) shows that despite massive capital expenditures on AI and hyperscale infrastructure, these companies generate even larger amounts of operating cash flow. This allows them to fund their growth internally while still having ample cash left for shareholder returns through buybacks and dividends.
- Market Seasonality: The podcast highlights strong historical data showing that the S&P 500 typically makes its high for the year in the fourth quarter. In years when the market peaks in Q4, the average annual return is significantly positive, suggesting a high probability of a strong finish to the year.
Quotes
- At 01:19 - "Nick Colas and Jessica Rabe are the co-founders of Datatrek Research and the authors of Datatrek's morning briefing newsletter, which goes out daily to over 1500 institutional and retail clients." - Josh Brown introduces his guests and their influential research firm.
- At 03:15 - "On the left-hand side of the chart, you can see during '21, they were huge beats because nobody thought companies could make as much as they did." - Nick Colas explains the massive earnings surprises in 2021 as companies recovered from the pandemic faster than analysts expected.
- At 05:30 - "The point here is that it's not just tech improving the S&P 500's overall net profitability." - Jessica Rabe discusses a chart showing that five out of eleven sectors are contributing to the year-over-year improvement in net profit margins.
- At 14:23 - "You want to compare Amazon and Apple today versus Bethlehem Steel? Is this an exercise that's helpful to anyone? It's different stocks." - Josh Brown argues that the composition of the S&P 500 has changed so dramatically that comparing current Shiller P/E ratios to historical averages is misleading.
- At 19:16 - "The S&P has peaked for the year in Q4, 71% of the time, over the last four and a half decades." - Jessica Rabe explains the powerful seasonal trend that favors a strong market close to the year, making an early-year peak statistically rare.
Takeaways
- S&P 500 earnings power remains robust, with margin expansion occurring across multiple sectors, providing a solid fundamental backdrop for the market.
- Historical valuation metrics like the Shiller P/E ratio should be used with caution, as the underlying composition and profitability of the index today are fundamentally different from past eras.
- The largest tech companies are generating immense cash flows, enabling them to self-fund aggressive AI-related capital expenditures while simultaneously returning significant capital to shareholders.
- Market history strongly suggests a tendency for stocks to rally into the end of the year, with the S&P 500 making its annual high in the fourth quarter over 70% of the time since 1980.
