And just like that, equities break out to new all-time highs and the big round 20,000 level gets broken on the Dow. And just as quick, the big debate in financial media becomes whether or not this market rally is justified, real or any number of other descriptions that pundits are coming up with for what is going on. When debates like this break out, it's important to realize that good capital market analysis is more art than it is science. Getting caught up in the minutiae of the moment is how one misses the big picture. With all the cross-currents of different asset classes going in different directions and even more narratives trying to explain them, the truth is there is no absolute answer. All we can do is look at price and how the economic backdrop is trending and position ourselves accordingly.
Let's take a look at the P/E for the S&P, since that's something many pundits are citing as showing the market is overvalued. Using last night's close of 2298 and the last four full quarters of GAAP earnings, the S&P is trading at a 25.7 P/E, whereas last year we were trading at 21. Does this mean that the market is overvalued or that all we've seen is multiple expansion? I don't think so. Considering that this time last year we were looking at a possible financial disaster being driven by a collapse in energy, I would say that the multiple expansion is absolutely warranted.
Today, we are looking at higher earnings coupled with unprecedented expansionary fiscal policies that are coming at a time when the economy is already growing. If anything, we can make an argument that the market is inexpensive, especially when we factor in the future tax law changes that have been promised by President Trump. Remember, equities are a discounting mechanism of future economic benefits. The better the future looks, the higher the price is today.
This leads us right back to the long running narrative of this space, which is staying focused on the actual data and letting it be our guide. We'll let the pundits argue about how real or not this rally is. At the end of the day, it's the price that counts, and last night's close of 2298 on the S&P is as real as it gets.
Taking a look at economic data that we've gotten, Tuesday gave us a couple reports on the manufacturing and services sectors from The Richmond Fed which covers the District of Columbia, North and South Carolina and Virginia areas. Like the Philadelphia Fed services report written about yesterday, financial media doesn't pay much attention to the Richmond Fed, even though they provide valuable metrics of the regional economy. That said, the reports showed strong activity for the manufacturing and services sectors.
The services report was rather robust as this line from the report goes:
"Revenue increases were prevalent, particularly among retailers. Big-ticket sales remained robust, and shopper traffic increased. "
That headline alone is enough to warrant plenty of attention.
The survey also showed growth in employment and prices. Now we have both the Richmond and Philadelphia Fed services surveys pointing to strong activity for January, which should be reflected in the Markit Flash US Services PMI due out later today.
On the manufacturing side, the Richmond Fed also showed growth, as shipments and new orders both picked up while prices continued to trend up. Just like the Philadelphia Fed and the general comments we are getting from the business community, Richmond Fed business optimism is also up. All in all, both the services and manufacturing reports painted a healthy picture of activity for the region, which is further justification of equities trading at current levels.
Taking what we've gotten thus far for economic data, actual earnings and highly constructive comments from companies like JPMorgan (JPM) and D.R. Horton (DHI) , who are proxies for major parts of the economy, I'd say this market rally is not only justified -- it's just getting started.