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Profit from the Pros

The S&P 500 Earnings Yield Shows Stocks A Great Buy

The markets got clobbered yesterday. And in my opinion, for all the wrong reasons.

The markets were up early, but gave back their gains as the morning wore on, with losses worsening by mid-afternoon, before bouncing up a little by the close.

The narrative was two-fold. After Caterpillar reported strong earnings and gave a bullish outlook, they suggested that Q1 was likely their high-water mark for the year. And that sent shares tumbling.

Then people began wringing their hands over the 10-year yield climbing to 3% with some suggesting this could foreshadow a recession.

Really?

Such nonsense.

For one, this earnings season is shaping up to be a fantastic one. And with the corporate tax cuts only just beginning to be felt, companies should see their prosperity grow in the coming quarters, not shrink. So I don't think CAT's 'as good as it gets' comments are a harbinger for the rest of the market. Quite the opposite. I think they will prove to be the exception.

As for the 10-year hitting 3%. So what. Going all the way back to the 1957 recession, and the 9 recessions between then and our last one in 2007, we've never seen a recession begin with rates below 3.90%. In fact, in 1957, the 10-year was at 3.93% right before the recession hit. And in subsequent recessions, rates were closer to 5%, 7%, 12.5% and even as high as 15% before recessions got started. And just looking at our last two recessions, the 10-year was at 4.10% in 2007, and 4.89% in 2001. This is much ado about nothing.

BTW, recessions entail two quarters in a row of negative GDP. Our last GDP print was 2.9%. And this came after our GDP averaged just 1.5% for the first 8 years of this bull market recovery. And with historically low unemployment, robust job growth, virtually every economic measure pointing to an expanding economy, and consumer confidence near record levels, talk of recession is downright comical.

Lastly, let me also point to the spread between the 10-year Treasury yield and the S&P 500 earnings yield. At the moment, the 10-year yield is at 3.00% while the S&P earnings yield (using the 12-month forward estimate) is at 5.93%. That's nearly a 300 basis point spread. I wouldn't even begin to think about a recession or a bear market until the spread narrowed to less than 100 basis points. And I can't imagine any scenario, even remotely credible, for that to happen any time soon.

So ignore any doom and gloom talk about earnings and rates and recession. It's illogical noise.

The market looks well supported. And I'm expecting much better things to come. Because the data suggests that's where we're headed.

Remember, buy the dips, and buy the rallies.

See you tomorrow,

Kevin Matras

Executive Vice President, Zacks Investment Research

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