Click here to watch Agili’s latest video, Agili Market Insights: Second Quarter 2022 Views. A full transcript of the video, featuring Michael Joyce, is below in italics
Hi. This is Michael Joyce, from Agili, Your Personal CFO, and I’m here to share with you our thoughts and viewpoints for the Spring of 2022.
Price/Earnings Ratio Explained
Now I’m going to start off today with a little tutorial on P/E ratios. So, the P stands for price and we’re talking about the share price of a company. The E stands for earnings and we’re talking about earnings per share of a company. The value of any company – whether it’s Apple or Microsoft or Exxon or Agili — is the value of all the company’s future cash flows discounted back to the present value.
Now we don’t know what all the future cash flows are going to be and that’s why stock prices move around all the time — because investor perceptions of future cash flows are always changing. But we do have a good idea of what the discount rate is. Most people invest for the long-term, so we use long-term interest rates as a proxy for the discount rate.
At the beginning of this year, on January 1st, the ten-year Treasury note had a yield of 1.6%. And at that time, the stock market was trading at about 22x earnings – which is higher than its historical price earnings ratio – but considering that interest rates were very low at 1.6%, that was quite reasonable.
So what’s happened since then is the E part, earnings have gone up a little bit, which we expected, the P part has come down a little bit. Stock prices have regressed a little bit, but more importantly, since then, the yield on the ten-year Treasury note, as of the date I’m doing this in mid-April, is at 2.9%. And most of that’s come since March 1st. So, the price earnings ratio on the US stock market is now about 20x earnings – which is down a little bit from the beginning of the year, but probably is a little bit high from where it should be based on a 2.9% rate to discount future earnings.
So, we have that at a little bit high right now and what we’ve struggled with this whole year has been rising inflation and rising interest rates. And that has really impacted households and businesses. It costs more to buy stuff. It costs more to borrow. Mortgage rates are now up over 5%, so it’s more expensive to finance the purchase of a home. And one concern is that’s going to impact aggregate demand and then may impact earnings, the E part. So, while we’re worried about whether the P part is too high relative to interest rates, we also have to worry at the same time that the E part might also decline a bit. So, as I’ll talk about, that’s giving us a little bit of pause and overall making us much more careful and cautious.
Market Trends and Inflation
Now there are very positive things. While people may be buying a little bit less in terms of cars, boats, or just plain stuff, they are looking to buy more experiences, they’re looking to travel more. They’re just basically looking for anything to provide some more social interaction.
We also think there’s going to be greater demand for public health initiatives given the recent pandemic.
And inflation, as we know, has been running very high. It’s been at a 40-year high – it’s been over 8%. But there are some signs that that may begin to moderate a little bit. And some of that is coming from the supply side; supply chains are starting to get a little bit better; they still have a long way to go.
Encouraging Labor News
And there’s also encouraging news on the supply of labor. Again, there’s still a ways to go with that, but unemployment has fallen to the rate that it was prior to the pandemic. And while the labor force participation rate hasn’t fully recovered yet, we are seeing some green shoots of positivity there as well. For example, there are more women entering back into the labor force. Many of them had stepped out of the labor force to take care of their kids — because of the lack of childcare, their kids were doing Zoom school. We’re also seeing workers who are over the age of 55 and who had also stepped out of the labor force because they were spending less money during the pandemic, they’d saved up a little bit more, so they figured they could get by, at least in the short-term. But now, with higher inflation, things are costing more money. So, they are also, to some extent, coming back into the labor force. So, there’s really good news from that standpoint.
Bond Market Analysis
Also, this year, the bond market has really gotten killed. As interest rates go up, bond prices come down. And, in particular, longer-term bonds are more sensitive to interest rate movements. And inflation is the archenemy of bonds. If you buy a bond today for a set amount of money, you’re going to get paid back that set amount of money plus interest when the bond matures. But because of inflation, that amount is not going to buy as much stuff – it’s not going to go as far at that time.
Now at Agili, we have focused for the past several years, on shorter-term bonds. And shorter-term bonds are less interest rate sensitive. If you think about it, if you have a bond that’s going to mature in 6 months or a year, it doesn’t matter if interest rates go to zero or 20%, you’re still going to get paid back at maturity, plus interest.
Now that we’ve all filed our tax returns or extended our tax returns to pay or file later, we think now is a good time to take stock of where you are relative to your financial goals and objectives. And with Agili, many of our clients, their goal is a comfortable retirement. We call it financial independence. So especially given the fact that there has been a pull-back in the markets, it probably is a good idea to meet with your financial strategist at Agili and look at where you are relative to being financially independent. Are you on track to have a comfortable retirement? Or do you need to make some changes – whether it’s in terms of allocations, or savings rates, or spending rates, or whatever. Now is the time to do that – and we would encourage you to do so.
I’ve been very pleased to share with you my tutorial on price earnings ratios as well as our thoughts and viewpoints for Spring 2022. If you do have any questions, feel free to contact financial strategist or contact me. Thanks, and have a great day.