The Russell 2000's P/E Is Very Misleading

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Yelp has this metric that measures local economic activity in the U.S. called the Yelp Economic Average (YEA). The YEA is a report that comes out quarterly and measures business and consumer demand across 30 sectors such as restaurants, food, nightlife, local services, automotive, professional services, home services, and shopping.

As of June 15, 140,000 businesses listed on the Yelp YELP, remain closed due to the coronavirus pandemic. And of all the business closures since March, more than 30% of them have shuttered permanently. According to Macro Analytics & Techical Analysis Strategic Investment Insights, during the next bust cycle, almost 50% of companies will be unprofitable.

Goldman Sachs economists led by Jan Hatzius slashed their third quarter U.S. GDP forecasts by 8% to 25% growth in a new note to clients. Previously, Goldman Sachs expected 33% growth fueled by the re-openings of states that has sent a flood of people back to spending in bars, restaurants and retail stores. But with COVID-19 infections spiking again in several states and governors reinstating some form of lockdowns, Goldman thinks the economy is poised to underperform their prior estimates.

For one, the forward price-to-earnings multiple on the S&P 500 is 21.7 times, a level not seen since the late 1990s internet bubble, according to Yardeni Research. This level of valuation seems to blatantly ignore the headline risk of the coming second quarter earnings season, where S&P 500 earnings are expected to tank 43% year-over-year.

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The Russell 2000 index represents the largest 2000 small cap public companies in the US. On avg. four out of ten of these companies are not generating any earnings. And that number is expected to increase in the future.

According to Morningstar and iShares the P/E for the Russell 2000 is 17.5 and 14.1, respectively. But the P/E for the Russell 2000 excludes those small and mid-cap companies losing money, making the P/E appear to be undervalued. According to Vincent Deluard, global macro strategist at investment firm StoneX, the Russell 2000’s forward P/E currently is 132.

The first-come, first-serve Paycheck Protection Program of $349 billion had promised to ease some of the financial burden for the nation’s smallest businesses.The goal was to aid companies with less than 500 employees, but larger public companies initially took advantage to tap the funds for themselves. Over the past weeks, dozens of publicly traded companies have since returned money.

The program was initially rolled out in April, offering $349 billion to small businesses. According to Ron Temple, head of U.S. equity at Lazard Asset Management, small business account for 47% of all American workers. The government-backed program kicked off in April and ran out of money less than two weeks later before the Trump administration sent out another round. So after those funds quickly ran out, the government replenished the program with an additional $310 billion.

Despite the unemployment rate falling, more people are losing their jobs... permanently. Nearly 90,000 companies in the program took the aid without promising on their applications they would rehire workers or create jobs.

Back in June, the Russell it the daily supply at 1515 and since that time has pulled back.

They say the Russell 2000 leads the way down and leads the way up. Until the Russell breaks out to the upside above the daily supply, I can't believe the equity markets will continue to go up indefinitely. A break below the upside trendline and we could see a major correction on the broader markets.

This post is my personal opinion. I’m not a financial advisor, this isn't financial advise. Do your own research before making investment decisions.

Posted Using LeoFinance



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