You have looked at the recent stock market indicators around the world that indicate a rise in stock prices, and you are wondering, what is going to happen to the stock market? But the performance YTD has been rather impressive: is this an indication that stock prices will go down or will it crash? Or will the return be in line with the other economic indicators which point towards steady, healthy economic growth? The current P/E levels associated with rising stock prices do not necessarily indicate a market correction; profit margins are also valuable market indicators for economic growth. Is it already priced in the market?
Let take a closer look at the S&P. For example, let’s take a close analysis at the current P/E levels. According to Thomas Reuters and Credit Suisse, Shiller P/E levels do indicate that US equities are at elevated levels. The current Shiller P/E levels are at 24x, which is normally a multiple that is not associated with failing markets, but in a dangerous zone. Normally when markets have failed, the Shiller P/E has been at 26x or above. There are other P/E levels which also do not indicate an impending market crash.
Current profit data also does not clearly indicate that the market is going to crash either. For example, according to Deutsche Bank and Bank of America Merrill Lynch, profit net margins for S & P companies and industrials are currently at 8%, just a point higher than they were in 1966 and in 1999. Therefore, their research indicated that even though profit net margins are susceptible to cyclical swings such as the financial crisis of 2008, current numbers indicate that they are on a sustainable upward trend for the long-run. Deutsche Bank’s explanations for this higher net profits margin are because of increased foreign sales. Foreign sales tend to be at lower costs than domestic sales, therefore in a the long run leads to higher profits. For example, as of 2013, companies who sell abroad have a profit margin of 14%, while a company that has no sales abroad has a profit margin of 7.8%.
According to FRED, the Board of Governors of the Federal Reserve System, and research.stlouisfed.org, treasury constant maturity rates are decreasing at an estimated 2.0 points lower than they were in 1960. This, as Business Insider argues, has resulted in lower interest expenses, which is enabling companies and industrials to increase profit margins in the long-run.
Other telling indicators which can help point towards economic growth rather than impending economic failure are the current debt levels. According to UBS, S & P, Compustat, FactSet and RBC Capital Markets, S & P 500 net debt equity has fallen from its 90% rate in 1995, to its current 2013 45% rate. These indicators that lower debt rates will help to buffer rising stock prices and higher profit margins from causing any damage to the market.
In conclusion, there are current economic and market indicators that point towards steady, economic growth and health rather than a market correction. The stock market prices seem to be rising because of increased profit margins, lower debt levels and lower interest expenses. Just keep an eye on these indicators and the P/E level to make sure they remain at this level and your investments should be alright. The alpha banker predict a nice Christmas period, without any major exogenous events.