Fairly Highly Valued
Bulls and bears have been battling it out this year, and the bulls have the upper hand. Bulls are focused on continued massive AI spending, worldwide easing of interest rates and decent corporate and consumer balance sheets. Bears are focused on near-term seasonal headwinds, corporate buyback blackouts, and the lagged impact of tariffs. Federal Reserve Chair Powell said on Tuesday that asset prices are at elevated levels generally and that equity prices are “fairly highly valued.” In the run-up to last week’s Fed policy meeting, stocks rallied strongly as conviction grew that that the Federal Open Market Committee would lower its overnight borrowing rate. Stocks set a succession of record highs since the decision last Wednesday to cut rates by a quarter percentage point, although markets have been giving back some of those gains over the last two days. Though Powell noted the lofty equity values, he did note that this is not a time of elevated financial stability risks.
Looking at valuations, the forward 12-month price to earnings ratio for the S&P 500 is indeed elevated at 22.6. This is above the 5-year average of 19.9 and above the 10-year average of 18.5. At the sector level, the Technology and Consumer Discretionary sectors are trading close to 30 times earnings, while the Energy sector is trading at a mere 15 times earnings. So yes, markets are highly valued versus historical levels on a number of measures in the aggregate, but “overvaluation” can continue for a long time. Previous Fed Chairman Alan Greenspan warned about “Irrational Exuberance” in 1996, 3-4 years before the peak in dot-com related internet stocks. Corporate conditions and profitability are much improved from the dot-com bubble era, but the question remains whether this is a “new normal” or a rhyme of history.
New home sales surge
New-home sales in the US unexpectedly surged in August to the fastest pace since early 2022, likely lifted by builder price cuts and sales incentives to motivate buyers. Sales of new single-family homes increased by over 20% to an 800,000 annualized rate in August. The median sales price in August was $413,500, up 4.7% over July and up about 2% over last year. The data suggest US homebuilders are successfully luring buyers off the sidelines with aggressive sales incentives. This month, 39% of builders reported cutting prices, a post-pandemic high. Homebuilder Lennar# recently reported offering sales incentives equal to 14% of its average sale price, more than double its usual 5% or 6%. The figures capture the start of a recent slide in mortgage rates that now stand at the lowest level in a year.
While homebuyer demand typically tends to decrease during the fall, purchase application activity remains relatively strong right now. Mortgage applications to purchase a home were up 18% from the same week one year ago. The average interest rate for 30-year fixed-rate mortgages decreased slightly to 6.34%, the lowest level in about a year. Refinance demand, which had spiked dramatically higher the previous week, climbed just 1% for the week but was 42% higher than a year ago. Moves by the Fed to lower interest rates may have had more of a psychological impact for home buyers as lower expected rates plus builder incentives stimulated demand.
Corporate Earnings Take the Escalator Up
Company earnings continue to march higher despite recent tariff impacts. With the third quarter winding down, earnings for S&P 500 companies are expected to increase by about 7.7% over the prior year. Revenue for these companies is expected to increase about 6%. Eight of the eleven sectors in the S&P 500 are expected to report earnings growth, with technology again the standout. Tech sector earnings are projected to grow by over 20%, led by the nearly 45% growth expected in the semiconductor space. Tariff mitigation measures, which have been well received in recent quarters, are likely to get additional scrutiny given concerns about broader labor market paralysis. Looking ahead, S&P 500 company earnings are expected to increase about 11% this year and 14% in 2026.
Equity markets around the world have generated solid gains so far this year, though a bit of air has come out of several AI related stocks. Corporate earnings growth needs to come through in order to keep the ascent going. Looking ahead on economic data, this week brings an update on Q2 GDP, durable goods orders, jobless claims and existing home sales. Friday we will get the personal income and spending report, including PCE inflation. Another potential U.S. government shutdown looms, adding to near-term worries. As President Trump walked through the United Nations headquarters on his way to speak this week, the up escalator suddenly stopped. Let’s hope the economic escalator continues to run smoothly as we move into the last quarter of the year.
Catherine Zeta-Jones turns 56 today. She is married to Michael Douglas who turns 81. Also, actor Will Smith turns 57, Mark Hamill (Luke Skywalker) turns 74, and Heather Locklear turns 64.
Christopher Crooks, CFA®, CFP® 610-260-2219