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LOOK OUT MARKET IF EXPECTATIONS DO NOT BECOME REALITY

THE MARKET – EXPECTATIONS NEED TO BECOME REALITY

As vaccinations are given, new cases and deaths from Covid-19 decline, trillions of dollars are pumped into the economy, tax filing deadlines are delayed, mortgages are allowed to stay in forbearance, evictions are forbidden, education loan payments are halted, and the FED vows not to raise interest rates for years, stocks have not only made a miraculous recovery, but have gone on to hit new records. Of course, all this free money and largess will have to end at some point. When that happens, stocks’ lofty levels will then need to rely on companies’ operations and profits. On-going business will need to justify stock prices at some point.


Will business return to a level that will match expectations? Herein lies the rub.


In order to flesh out this issue, TPA examines one industry that was and still is a focal point of the Pandemic; restaurants.

The chart and table below show the PE and 12-month forward PE (Bloomberg) for the S&P1500 Restaurant Index. The index is made up of 22 restaurant stocks ranging from MCD (market cap $167 billion) to FRGI (market cap $407 million). The current PE and forward PE of the Restaurant Index is 56 and 31, respectively. This compares to a 10-year average PE and forward PE of 24 and 26. The overvaluation on a PE basis is okay if we assume that life returns to normal sometime in the next year.


For another perspective, TPA provides the actual PE and forward PE of each stock in the index in the table below. Using a 5-year average PE, TPA calculated the percent above the 5-year average PE for both statistics. Using PE, most of the stocks are very overvalued, but using forward PE/5-year average PE, most of the stocks are undervalued.


As is normally the case, the current market levels involve forecasts of future outcomes. The problem with Restaurant stocks and, generally, most stocks right now, is that forecasts are based on a huge pile of unknowns. The market is betting that Covid-19 is vanquished and that once all the guardrails that have been put in place are removed, the economy will drive safely down the road. For this analyst, that means an awful lot of things have to go according to plan. That makes this stock market a lot riskier than it may seem. TPA clients should watch for signs that all is not going according to plan.


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