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Corporate Earnings vs an Inverted Yield Curve

By:

Chief Market Analyst, Stock Traders Daily

With the economic concerns and yield-curve inversion fears that exist as a result of tariffs, we thought it would be good to look at what matters most to Wall Street, and that is Corporate Earnings.  The focus of this piece is on The Dow Jones Industrial Average, but the same can be said for the other markets, too.

Arguably, the Dow Jones Industrial Average is the most difficult to quantify because of how the constituents impact the Market itself.  The S&P 500, NASDAQ 100, and Russell 2000 are easier for quantifying valuation than the Dow Jones Industrial Average, so this information is arguably the most challenging to obtain as well.

Goal: to understand how expected changes to earnings will impact valuation for the stock market.

The information in the charts below come from consensus estimates for earnings for the stocks in the Dow Jones Industrial Average, and immediately something important is revealed.  This year earnings for the Dow Jones Industrial Average is expected to decline by 20%.

A decline in earnings makes valuation stretched, and we can see that in both the chart for the PE ratio and the PEG ratio for the Dow Jones Industrial Average below.  This year, the Dow Jones Industrial Average will have a PE ratio of over 20 times earnings and a PEG ratio lower than -2.

However, next year earnings are expected to grow by 28% based on analysts’ estimates.  Where this year earnings are expected to decline by 20%, next year earnings are expected to increase by 28%, and if that happens valuation levels will look much better next year.

Again, using the same charts, if earnings growth in 2020 is 28%, the PE ratio will only be 16 times earnings, much more reasonable for the Dow Jones Industrial Average historically, and the PEG ratio would be 0.54, representing a solid value if that earnings growth rate could be sustained.

Clearly, the earnings growth estimate for 2020 is significantly higher than 2019, and some might argue that is because of tariffs.  Where they are expected to impact earnings in this calendar year, analysts may very well have a Trade War resolution priced into their expectations for earnings next year.

Stock Traders Daily has written extensively about this topic and publications can be found through Reuters, Refinitiv, Zacks, Factset, Interactive Brokers, and on our web site.

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