Let's keep it simple. Sentiment and valuations tend to go hand and hand. When things are good...
people feel great,
stocks move higher,
people feel better,
valuations rise,
then boom.
This cycle repeats itself over and over. Some cycles are long (ie current one), some are small, but sentiment always plays a role.
I want to be clear, sentiment is not a good proxy for determining what something is worth, but it is a decent gauge for what someone will pay for something at a point in time. You are more likely to overspend on something right after you get your tax refund, then right after Christmas shopping is over.
So what am I getting at.
Below is a chart of the Consumer Sentiment index dating back to 2000. It is a decent gauge of how consumers feel about their financial situation and their short and long-term view on the economy. In green, I highlight the S&P 500 forward PE, and rolled it back 6 months. So in a sense, we are looking at how consumers feel today, and historically the 6-month track of S&P Forward PE levels.
Two Thoughts:
1. First thought is that there is an apparent divergence taking place. Confidence is gaining, yet valuation multiples investors are willing to pay are falling. I can blame a series of events such as the rise in rates, which in theory is an input for valuations, but if confidence is high and growth is potentially moving higher (not my opinion), then rates and growth could offset. If the historical track holds, with all else being equal, that would mean a re-rating of equities is coming.
2. Or, confidence is peaking? Could it be that confidence is topping and investors are de-rating the market multiple as they anticipate growth to slow in the future? Maybe. As I have expressed over the last 3-4 months through my "deadly duo" graph, there are a ton of input costs to consumers which I don't think are being accounted for.
Either way, this Friday at 10 am we get an update of the Consumer Sentiment Index, along with Q1 GDP. It will be interesting to see how higher gas prices, higher rates, Syria, trade tariffs, tax cuts, all accumulate in this months sentiment reading. Remember, the US economy is 70% consumer driven, so I'll be observing closely.
That's it. Make sure to subscribe to future blog posts.
Sean D. Emory
Avory & Co. Founder & Chief Investment Officer
Disclaimer: This is not a recommendation for purchase or sale of any securities.
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