Strategy: Noise-to-Signal Ratio
The 10-year Treasury bond yield edged up above 3.00% yesterday (Fig. 1). This widely feared level didn’t faze the S&P 500, which rose 1.0% on Wednesday to 2697.79 (Fig. 2). Rising oil prices, in response to Trump’s no-deal with Iran, helped to lift the S&P 500 Energy sector (Fig. 3). But the Tech and Financial sectors also had a good day yesterday (Fig. 4).
While the 10-year yield suggests that credit conditions are tightening, the yield spread between US high-yield corporate bonds and the 10-year Treasury bond continues to fluctuate in a tight range at a level that matches previous cyclical lows (Fig. 5). All of the volatility in the S&P 500, and the downside pressure on this index, so far this year have been attributable to the forward P/E of the index, which has dropped from a high of 18.6 on January 23 to a low of 15.9 on May 3 (Fig. 6).
The forward P/E has been very noisy so far this year on fears of higher inflation, tighter Fed policy, and trade protectionism. It has masked the underlying bullish trend of the S&P 500 forward earnings (Fig. 7). Thanks to Trump’s tax cuts at the end of last year, this weekly measure of industry analysts’ consensus estimates for earnings over the coming 52 weeks has been soaring since the start of the year. Our Boom-Bust Barometer (BBB), which is the ratio of the CRB raw industrials spot price index to initial unemployment claims, continues to be highly correlated with S&P 500 forward earnings. Our BBB rose to a record high at the end of April.
It is also highly correlated with the S&P 500 stock price index, but less so than with forward earnings (Fig. 8). That’s because there is more noise than signal in the S&P 500 than in forward earnings.
Joe and I have managed to tune out most of the noise and focus on hearing the signal since the beginning of the current bull market. We hope we will continue to do so. In our opinion, the signal remains clearly bullish for now despite the noise.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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