Stocks need earnings growth, rate cuts to defend current high valuations – JPM
Stocks need earnings growth, rate cuts to defend current high valuations – JPM
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This year’s equity gains have been driven more by expanding price-to-earnings (P/E) multiples rather than by earnings growth, JPMorgan strategists highlighted in a Monday note. With a 30% rise in P/E from October 2022 lows and a current US forward P/E of 21.4x, the focus remains on central bank policies.
Strategists suggest that if central banks become more dovish than expected and earnings growth does not disappoint, the current high equity multiples “could be defended,” according to JPMorgan strategists.
“However, if activity momentum, and in particular earnings delivery, disappoints, and central banks end up more reactive than proactive, then we think that equity multiples would need to fall” they added.
So far in 2024, earnings per share (EPS) projections have seen a slight decrease in the United States and a more significant drop in Europe. Concurrently, bond yields have risen, putting pressure on equity risk premiums (ERPs).
“Global earnings yield vs bond yield differential has been moving lower, to be now below 2007 levels,” strategists wrote.
“Central banks are set to deliver some cuts in 2H, but in order to justify current equity valuations, we believe that we will need to see at least some earnings acceleration, as well.”
The recent expansion in P/E ratios reflects investor optimism that economic activity is nearing a trough and anticipates an acceleration in earnings growth in the coming years. This outlook is supported by IBES forecasts, which predict a steady increase in earnings growth from 2023 to 2026.
Ultimately, the trajectory of equity valuations is likely to align with trends in earnings momentum, given the historical link between P/E multiples and earnings revisions, JPMorgan’s team noted. In particular, the last 18 months have witnessed a moderation in the pace of earnings downgrades, raising concerns among strategists about whether there will be a consistent uptrend in EPS growth.
“If the earnings acceleration fails to materialize, this could act as a constraint, in particular for Cyclical sectors, which are currently trading at price and P/E relative highs vs Defensives,” JPMorgan strategists said.
