The CJ Lawrence Market Monitor: Navigating Earnings Season and Market Valuations

Terry Gardner shares a mid-earnings season check-in that covers interest rates, valuations, and the Rule of 20’s impact on the Stock Market’s future.

It’s Thursday, the 24th of October, about a third of the way through earnings season for the third quarter of ’24. I thought we should take stock of where we are right now, but also take a second to take a step back because a lot has happened in the last few weeks.

Let’s see what the CJ Lawrence Market Monitor is telling us, and then take a look at valuations. There’s a lot of chatter in the market today, and in the financial media, about the market being expensive or priced just right. First, let’s revisit the trusty CJ Lawrence Market Monitor. What is it? The Market Monitor was created by my mentor, and our mentor here at CJ Lawrence, Jim Moltz, back in the 1980s.

The goal was not necessarily to create a timing tool, but to put together a series of metrics that would help investors gauge whether the timing was good to invest in equities, particularly in relation to fixed income. This market monitor was created containing six components, all with fundamental interest rate or technical and breadth components to them. The sum of the monitor components gives us a reading that offers a relative feel for where we are in the cycle and the attractiveness of stocks. I was just looking back at some past monitor readings, and this one goes back all the way to 1988. This model has been around for a long time, it’s been obviously time tested and has had an excellent track record over time, not necessarily of timing entry and exit points, but of calibrating the appropriateness of a heavy or lighter equity allocation.

Where’s the monitor today? The monitor has moved from a kind of neutral stance to a positive stance, a solid positive stance. Out of a possible reading of six, it’s at a positive three. What’s moved the monitor from more of a neutral stance over the last 30 to 60 days has clearly been the move in interest rates. When the Fed finally reduced rates at the short end of the yield curve by 50 basis points, that flipped the interest rate sensitive models over from being in kind of a neutral negative stance, where rates were going up, to one where rates are now going down, turning the sentiment in those models in a positive direction. When you weigh them all out, the fundamental components are mixed. The interest rate models are now positive because it looks like the direction of interest rates is negative, or rates are going down. The breadth and the technical measures within the model and the monitor are positive because we’ve seen stocks reacting to that backdrop and have done well. We’re up close to 22% year to date on the S&P 500. That’s a strong year in any year if it ended today. The market monitor is telling us to stay on the course. When you take a step back from all the machinations that are happening and all the conversations going on in the market on a day-to-day and week-to-week basis, the market monitor is telling us that the coast is pretty clear.

Another model we like to look at in terms of valuations is the Rule of 20. You’ve heard us talk about the rule in the past, and the Rule of 20 has been elevated, really, for the last two to three years.

The Rule of 20 takes the market multiple, the price-earnings ratio on the stock market using the S&P 500, and adds the rate of inflation. When you add those two together over the past 50 or 60 years, for some magical reason, the result is around 20. We have been elevated for the past three years because we’ve had a very high level of inflation and haven’t had a corresponding dip in the price-earnings multiple on the S&P 500. Essentially, the markets have looked through the inflation and said, look, inflation will come down, and it has. Where’s the ratio today? If you take a look and say, well, I think the market multiple on next year’s earnings is about 22 times, and throw a 3% inflation on there, you’ve got 25 as a Rule of 20 reading–five points ahead of where that average is, but it’s been 23, 24, 26, 25 for the last couple of years.

It’s high, but it’s been high, and that hasn’t held back stocks. When I looked at the past couple of years for valuations, if you take a look at price earnings multiples going back 30, 40, 50, and 60 years, you will find much lower levels of multiples on earnings in previous decades– but if you look at the last 10 years, PE multiples have been relatively high. My theory is that’s because information flow is more prevalent today than it ever has been, Investors can get comfortable with looking ahead 12 months or 24 months to value stocks. In past decades, you often used to receive your information on earnings and cash flow multiples in physical paper, and it was all kind of historically based. If you looked at the 50s, 60s, and 70s, those multiples were based more on historic trailing 12-month valuations on earnings per share.

Today, we’re looking out a little bit further into the future, and investors have that comfort level with trading up at higher multiples. If I just look at the last couple of years, it’s kind of tough with Covid being in the 2020 and 2021 periods where earnings were depressed and prices hung in there, hence the multiples were kind of high. But even in 2018 and 2019, the forward multiple and the S&P 500 was 22.3. In ’20, it went to 20.2. These are four-quarter forward multiples. I’m just throwing out some numbers here to give you a feel for where 22 times the next four quarter forward earnings. We were at 20 and a half, 18.5 in 2022, which was a dip. 19.6 in ’23, and now we’re at 22. It’s a little elevated, but we’re not at 30, 31, 32. I mean, the NASDAQ traded 36 times earnings when the internet bubble was inflating. I don’t think we’re at those egregious levels.

As I mentioned, we’re in the early stages of earnings season. I’ll leave you with this. We’ve got about 30% of the companies in the S&P 500 having reported, and I would say the results are somewhat mixed. About 78% are posting positive surprises, which is a little bit lower than we’ve seen in past quarters. It looks like the quarter is going to come in with about two and a half percent growth. That’s where it’s coming in now, versus the same quarter last year. It’s a little bit below where we thought we’d be, but where are the outliers? There are certainly some that have fallen short, but the outliers are again in technology.

Leadership could return to technology, and keep an eye on that because technology companies are delivering whether it’s semis or software, they’re delivering on earnings and their forecasts are going up for next year. Markets rotate, but let’s stay focused on the innovators as we look out into next year. If you have any questions about the monitor, evaluations, or any of this, please give me a ring. We’ll come back to you once the earnings season is complete and reported and do a dissection of where the growth came in and what the outlook is for next year.

In the meantime, feel free to give me a ring at 212-888-6403, or shoot me an email at tgardner@cjlawrence.com.