ICON Insights | October, 2024

Equities

With various indexes hitting all-time record highs in late September 2024, it is only natural to wonder if the stock market has gone too far, is forming a peak, and if there is a potential bear market ahead? At ICON, we believe the answer is no, and that the market can continue moving higher. The graph below shows the earnings per share (EPS) for the S&P 1500 index

with 2024 – 2026 being estimates from a survey of analysts. There was a dip in 2020 when the economy shut down to try to reduce the spread of Covid and there was a pause in 2023 when the Federal Reserve was raising its Federal Funds target rate. Otherwise, it is a picture of prosperity which would seem to support or justify the current level of stock prices. In the ICON valuation equation, which we apply to approximately 1500 stocks, earnings per share is the most important input. As earnings have grown; intrinsic values have grown. Our market value/price reflects that as it has remained above 1.00 over the last year. In other words, stock prices have risen, due to earnings so has fair value.

Let’s break down those earnings by market capitalization; large, middle and small. The table at right shows the annual rate  of change for the earnings per share for the S&P 500, Mid-Cap 400 and Small-Cap 600 indexes. Again, 2024 – 2026 are estimates from a survey of analysts. All three dropped in the recession of 2020, and all three rebounded the next two years. There is a theory on Wall Street that increases in interest rates (tight monetary policy) is more problematic for small companies than for large ones. The drop in earnings in 2023 would seem to support that view and indeed, small cap stock prices were very sluggish until lately. The Small-Cap 600 beat the (large-cap) 500 Index the third quarter as investors may be looking out to 2025 and 2026 pricing in earnings projections.

We believe the market can move higher but with a new theme or personality. The third quarter was a bit of a tug-of-war with the market transitioning from the old theme to the new theme as monetary policy went from tight to easing. In late 2023 and the first half of 2024, the participation was very narrow and small-caps and dividend paying stocks were sluggish. Going forward we expect broader participation in the advance with small-caps and dividend paying stocks either leading or at least fully participating.

Bonds

The Federal Reserve’s goal of 2.0% inflation seems attainable to us. If inflation does get down to or near 2.0%, what is a sensible yield for the 10-year Treasury note? Those notes are considered free of default risk because they are backed by the U.S. Government, but they do have price fluctuation risk as interest rates vary. So reworded, what is the appropriate “real” (above inflation) return for taking that price fluctuation risk. A fifty-year average is two percentage points but we believe that is excessive. Because investors incorrectly feared the high inflation of the late 70s and 80s would return, they priced bonds with an excessive real return for a couple of decades. If we assume one percentage point is a fair real return, the 10-Year Treasury should gradually slip down to a 3.00% yield over the next couple of years. Currently it is 3.77%. Although ICON believes the Fed’s target of 2.0% inflation is attainable, many investors do not share that belief. Their influence may keep the yield on the 10-year Treasury higher than the 3.00% we have projected.

Summary

From June 2023 through August 2024, the Fed kept its tight monetary policy fairly steady. Federal Funds averaged about two percentage points above trailing one year inflation. Apparently concerned about the potential negative economic effects of tight policy, investors could only embrace a few narrowly focused unique growth stories such as artificial intelligence or weight loss drugs. Now, with the Fed easing monetary policy we expect entirely different investor and stock price behaviors in a favorable setting for small cap and dividend paying stocks.   

Download the PDF here

The data quoted represents past performance, which is no guarantee of future results. Opinions and forecasts regarding sectors, industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry, or sector.

Investing in securities involves inherent risks, including the risk that you can lose the value of your investment. An investment concentrated in sectors and industries may involve greater risk and volatility than a more diversified investment. Investments in international securities may entail unique risks, including political, market, regulatory and currency risks. In general, there is less governmental supervision of foreign stock exchanges and securities brokers and issuers. Investing in fixed income securities such as bonds involves interest rate risk. When interest rates rise, the value of fixed income securities generally decreases.

Individual account holdings and composition may vary. Opinions and forecasts regarding sectors, industries, companies, countries and/or themes, and portfolio composition and holdings, are all subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security, industry, or sector.

ICON’s value-based investing model is an analytical, quantitative approach to investing that employs various factors, including projected earnings growth estimates and bond yields, in an effort to determine whether securities are over- or underpriced relative to ICON’s estimates of their intrinsic value. ICON’s value approach involves forward-looking statements and assumptions based on judgments and projections that are neither predictive nor guarantees of future results. Value readings are contingent on several variables including, without limitation, earnings, growth estimates, interest rates and overall market conditions. Although valuation readings serve as guidelines for our investment decisions, we retain the discretion to buy and sell securities that fall beyond these guidelines as needed. Value investing involves risks and uncertainties and does not guarantee better performance or lower costs than other investment methodologies.

ICON’s value-to-price ratio is a ratio of the intrinsic value, as calculated using ICON’s proprietary valuation methodology, of a broad range of domestic and international securities within ICON’s system as compared to the current market price of those securities. According to our methodology, a V/P reading of 1.00 indicates stocks are priced at intrinsic value. We believe stocks with a V/P reading below 1.00 are overvalued while stocks with a V/P reading above 1.00 are undervalued. For example, we interpret a V/P reading of 1.15 to mean that for every $1.00 of market value, there is $1.15 of intrinsic value which has not yet been realized in the market price.

ICON’s value-to-price ratio is a ratio of the intrinsic value, as calculated using ICON’s proprietary valuation methodology, of a broad range of domestic and international securities within ICON’s system as compared to the current market price of those securities. According to our methodology, a V/P reading of 1.00 indicates stocks are priced at intrinsic value. We believe stocks with a V/P reading below 1.00 are overvalued while stocks with a V/P reading above 1.00 are undervalued. For example, we interpret a V/P reading of 1.15 to mean that for every $1.00 of market value, there is $1.15 of intrinsic value which has not yet been realized in the market price.

The unmanaged Standard & Poor’s Composite 1500 (S&P 1500) Index is a broad-based capitalization-weighted index comprising 1,500 stocks of Large-cap, Mid-cap, and Small-cap U.S. companies. The unmanaged Standard & Poor’s (S&P) SmallCap 600 Index is an unmanaged index of 600 domestic stocks chosen for their market capitalization, liquidity, financial viability, and sector representation. The unmanaged Standard & Poor’s (S&P) 500 Index is a market value-weighted index of large-cap common stocks considered representative of the broad market. The unmanaged Standard & Poor’s (S&P) MidCap 400 Index is a widely recognized unmanaged mid-cap index of 400 domestic stocks chosen for their market capitalization, liquidity, and industry group representations.

Earnings Per Share (EPS): Earnings from ongoing operations; earnings per share equals total earnings divided by the number of shares outstanding.

Federal Funds: In the United States, the federal funds rate is the interest rate at which private depository institutions (mostly banks) lend (federal funds) at the Federal Reserve to other depository institutions, usually overnight. Changing the target rate is one form of open market operations that the Chairman of the Federal Reserve uses to regulate the supply of money in the U.S. economy.

The 10-year yield is the benchmark 10-year yield to maturity reflected by the current issue 10 year U.S. Treasury note.

Sources: Bloomberg

Please visit ICON online at ICONAdvisers.com or call 1-800-828-4881 for the most recent copy of ICON’s Form ADV, Part 2.

© 2024 ICON Advisers, All Rights Reserved.