The Trump Stock Market Thunders On - Barron's

Photograph by Saul Loeb /AFP via Getty Images

Stocks are expensive–and extremely so—based on several measures. The S&P 500 is trading for almost 19 times projected 2020 earnings, one of the highest readings in more than 40 years. Stocks also look rich based on market value/gross domestic product, price/sales, and price/book ratios.

But they do look fairly valued based on the rule of 20, which reflects the market price/earnings ratio and the inflation rate. If the sum of the two is below 20, stocks look cheap. Above 20, they’re expensive. Right now, the total is around 20. Stocks are appealing based on the earnings yield (the inverse of the P/E ratio) less the yield on the 10-year Treasury. That is now around 3.4%.

Charles Schwab’s strategist, Liz Ann Sonders, jokes that when she steps into a room full of investors with varying views on the stock market, “I can hand each of them valuation metrics to support their view.”

The P/E ratio, she add, “is at the higher end of the range, but if you look at inflation or interest rates, the market is not expensive.”

Sonders notes that last year’s rally was driven almost entirely by P/E expansion, as S&P 500 earnings barely budged. “We’ve lost some of the macro tailwind” with the Federal Reserve moving to a neutral position, she says. “This year, the market will require earnings to step in.”

If the market follows earnings, it could be a pretty good year, with Goldman’s Kostin seeing a 5% gain in S&P 500 earnings, while a “bottoms-up” estimate from equity analysts based on the index’s 500 companies points to a roughly 10% profit gain.

Activist investor Bill Ackman’s main vehicle, Pershing Square Holdings (PSH.Netherlands), still looks like a good value after a phenomenal 2019, when the closed-end fund generated a 58.1% return.

The fund offers a way to play Ackman’s revival at a deeply discounted price relative to the value of its equity investments. The fund ended Friday at $19.70, a 27% discount to its net asset value of $27.07 a share. By comparison, most U.S.-listed closed-end funds trade for discounts of 10% or less.

While traded offshore, Pershing Square Holdings is open to U.S. investors and can be bought through brokerage firms like Charles Schwab and Fidelity. It trades on the Pink Sheets under the ticker PSHZF.

The six largest holdings in the highly concentrated fund are Chipotle Mexican Grilll (CMG), Hilton Worldwide Holdings (HLT), Restaurant Brands International (QSR), Lowe’s Cos. (LOW), Agilent Technologies (A), and Berkshire Hathaway (BRKA).

Why the big discount? Many investors are wary of Ackman after a terrible stretch from 2015 through 2017, when the fund lost 30% while the S&P 500 returned almost 40%. The fund has a lofty hedge-fund fee structure with a 1.5% annual management fee and an incentive fee of 16%. These issues, however, are reflected in the cheap price of the fund.

After a doubling its share price in the past year, Apple ought to consider scaling back its huge stock-repurchase program and boosting its dividend.

The stock, at a record $310, is no longer a bargain. It trades for almost 24 times projected earnings of $13.12 a share in the current fiscal year, against an average P/E of 14 in the past five years. The dividend yield is now just 1%.

Apple has the world’s biggest stock-buyback program. It repurchased $67 billion in its fiscal year, which ended in September, and paid out $14 billion in dividends. The capital-return program was funded by Apple’s $55 billion of earnings and a continued drawdown of the company’s big net cash position, which stood at $98 billion at the end of September. Apple has cut its shares outstanding by 20% since 2015.

Apple could take a more balanced approach and increase its dividend by 50% or even 100%, while reducing the size of the buyback. The company, which declined to comment, may have more to say about its repurchase program when it reports earnings for the December quarter on Jan. 28. (More on what investors should consider with Apple can be found on page 13.)

Looking for a contrarian play? U.S. natural gas is one of the few out-of-favor asset classes in the world after a year in which just about everything went up. Natural gas prices are down 25% in the past 12 months to $2.22 per million British thermal units and trade near a 10-year low, reflecting persistent oversupply despite growing demand.

Winter is normally the seasonally strong period for gas because of heating demand, but balmy January weather in much of the country—temperatures were forecast to top 60 degrees in New York over the weekend—is crimping demand.

Futures markets point to multiyear oversupply with 2022 prices around $2.50 per million BTUs. But much of the industry is unprofitable at current prices, and that could finally lead to meaningful cutbacks in drilling activity. Watch for what gas companies like Cabot Oil & Gas (COG), EQT (EQT), Southwestern Energy (SWN), and Range Resources (RRC) say on their earnings conference calls in the coming weeks.

Cabot, whose shares are down 20% to $17.50 in the past year, is the closest thing to a blue chip given its strong balance sheet. Southwestern, down 51%, to $2.09, in the past 12 months, and Range Resources, off 57%, to $4.90, amount to long-term call options on gas. Little-known EQT, down 55% to $8.90, is the country’s top gas producer, with 4% of daily output.

Energy debt, which has rallied lately, is a high-yielding alternative to the stocks. Range Resources just issued $550 million of six-year bonds at 9.25%, amid a slew of new junk-rated energy debt. The United States Natural Gas exchange-traded fund (UNG), which is off 31% in the past year to $17, offers a direct play on the commodity.

As the top consumer bank in the country, Bank of America (BAC) offers a window into the economy. CEO Brian Moynihan told Barron’s this past week (see page 12) that based on activity by the bank’s customers, the economy looks healthy. “We feel very good about what we’re seeing in consumer spending behavior, and the numbers are bearing it out on a real-time basis,” he said.

Moynihan said that the bank handles about $3 trillion of costumer spending annually from about 80 billion individual transaction, including checks, debit and credit-card payments, and peer-to-peer activity. He said year-over-year spending was up 5.9% in 2019, after an increase of more than 8% in 2018. “The fourth quarter was as strong as any quarter during the year, and the Christmas season was even stronger than that.”

Write to Andrew Bary at andrew.bary@barrons.com

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