Are U.S. Equities Headed for a Correction?

August 17, 2016

So far this year several macroeconomic issues have threatened to negatively impact financial markets. Yet U.S. equities have shrugged off all of these headlines and outperformed most peoples’ expectations. This week’s Chart of the Week takes a closer look at this strong return for the S&P 500 through July. Year-to-date, all of the positive performance has come from valuation appreciation. As a result, the trailing 12-month P/E ratio is now over 20, which is near its highest level over the last ten years. EPS, on the other hand, has actually fallen during the year, which is in stark contrast to the previous ten years when EPS growth was the main driver of price return. This phenomenon can be observed across the cap spectrum and in both value and growth indices.

Going forward, things may finally start to catch up with the U.S. equity markets. In addition to lower earnings, GDP growth has been weak the last three quarters, falling short of expectations each time. Furthermore, elections often affect markets negatively due to the increased uncertainty associated with a change in president, and with both candidates carrying unprecedented unfavorable ratings, the volatility impact may be magnified. If earnings do not reverse their recent downward trend, U.S. equities could be in for a rough second half of the year.