Monday, February 2, 2015

2015…the Year of P/E Compression?

What if revenues continue to rise AND profits similarly increase in 2015 yet stock prices remain stagnant (which, based on the January 2015 close is looking like a likely scenario), well then I believe we will have a classic case of Price-to-Earnings compression. Similar to a spring which is compressed by force, the dynamics of the stock market work in a similar, if not identical process, to the linear compression of a spring.

Over time increased revenues which translate to higher and higher earnings have typically reflected their respective advances in increasing stock prices.

When this trend deviates it is typically an abnormal movement in the traditional relationship which generally results in equilibrium (price appreciation) being restored at some point.

The question always, is when? When does the spring bounce back? If indeed GDP is slowing (possible, but with oil's fall it should remain strong), then we can expect the typical bounce back to occur when that point of "tensile" strength (i.e. greed) overwhelms the compression of earnings.

Historically this has been a rapid fulfillment of missed bounce. With nearly all the economic factors lining up in favor of increased GDP, low interest rates, low gas prices, lower manufacturing costs, increasing home values, and decreased unemployment we are in the midst of a great revenue cycle. 

In the short term stock prices may remain "unsprung," but over time the reflection of increased corporate profit should translate to a significantly higher market.