Dear Valued Clients and Friends –
Markets were slammed today, with the Nasdaq down -1.8%, the S&P down -1.65%, and the Dow down -1% (-370 points). The violence was most felt in the bond market as yields rallied dramatically at the long end of the curve. As yields did not move much (or at all) in the short end of the curve, you saw a fair amount of inversion eroded. It is all a rate story now – as stocks are following bonds, not vice versa. QT is tightening, and high rates are tightening (with the bond market doing more of it for them). Something has to break eventually.
The Bank of England also left its interest rate alone, pausing after 14 consecutive increases.
The House GOP was four votes short of having the votes needed to advance their compromise funding bill. Some tweaks are in motion to allow for a new vote next week.
*CNBC, DJIA, Sept. 21, 2023
Dow: -370 points (-1.08%)
10-Year Treasury Yield: 4.5% (+15 basis points)
Top-performing sector: Health Care (-0.92%)
Bottom-performing sector: Real Estate (-3.48%)
WTI Crude Oil: $89.59/barrel – flat on the day
Key Economic Points of the Day
- Initial jobless claims fell all the way to 201k, down almost 10% on the week. Both initial claims and continuing claims are at their lowest level of the year. Not. Exactly. What. Recessions. Are. Made. Of.
- Existing Home Sales declined -0.7% in August and are down -15.3% versus a year ago. This was the third month in a row of declining sales volume in existing residential real estate.
|“I hear you talk a lot about P/E ratios so I have some questions about them. What’s so important about the ratio? How do you use them? Why does a higher risk-free rate put downward pressure on ratios? Could P/E ratios start having a higher average that becomes the new standard to judge stocks by? Are there other things we should know about them? Maybe what I’m really asking for is a primer on them.”
~ Scott B.
|In a nutshell, the ratio captures the value of a company in the sense that all companies are, ultimately, valued by their earnings. It is not perfect because “earnings” and “free cash flow” can be different, and “EBITDA” can exclude interest and debt payments that can really matter for overly-indebted companies, but basically, a company is worth the present sum of future earnings with a discount rate applied for good measure. This piece might help a great deal (I am proud of this one). One can certainly also look to price-to-assets, price-to-sales, and any other number of metrics, but even then, those things are either (a) Anecdotal support to the message of the P/E ratio or (b) Only actually important because they are ingredients in how we get to earnings. A higher risk-free rate puts downward pressure on P/E ratios in the sense that more “risk-free” returns can be bought incrementally, competing for “risk-y” returns in obtaining company profits. The concept should be intuitive to most of you and is explained better in the link I provided a few sentences ago.
Yes, the “average” of a P/E ratio is always changing based on new developments – it is, by definition, a moving target. But a fact of life is (because of math) that a P/E ratio is, by definition, “the amount of years one has to wait to get their money back by investing in a company and getting all its earnings if those earnings stayed the same. Of course, they don’t – earnings go up and down just as the risk-free rate does. But when the 33-year average has been roughly 16x, for one to argue that now people might want to start waiting MORE than 16 years to get their money back on level earnings, it strikes me as a tough sell.
- Sam Rines discussing oil and energy is information and perspective at its best!
Send questions any time, and have a great night!
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
The DC Today features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet.