S&P 500: Strong earnings but stretched valuation risk – NBC

National Bank of Canada (NBC) strategists highlight that the S&P 500 has hit a fresh record high in August, supported by an exceptionally strong Q2 earnings season with roughly 50% year-on-year EPS growth. Yet they warn that forward EPS expectations, especially for Information Technology, are demanding, while a negative equity risk premium versus high long-term U.S. Treasury yields leaves the index sensitive to any earnings disappointment or renewed yield rise.

Earnings strength versus risk premium

"After two consecutive monthly declines, the S&P 500 reached a fresh record high in August. The rebound has undoubtedly been supported by a strong Q2 earnings season, with companies in the index reporting earnings per share growth averaging roughly 50% y/y, led by the energy, communication services and consumer discretionary sectors."

"On a twelve-month rolling basis, trailing S&P 500 earnings are now growing at their fastest pace in a generation, excluding post-recession rebounds."

"So, to maintain momentum, earnings guidance will need to be met—particularly in the IT sector, where expectations are especially demanding, with EPS growth of more than 40% anticipated over the next 12 months."

"With forward price-to-earnings multiples still hovering around 20, the S&P 500 earnings yield remains low relative to elevated long-term government bond yields, leaving the equity risk premium in negative territory for the first time in more than 20 years. As the 1997–2000 experience illustrates, a negative equity risk premium can persist for some time. The environment tends to become more challenging, however, as 30-year bond yields approach or move above 5.5%."

"Bond yields are especially relevant for growth stocks, whose valuations are more sensitive to changes in discount rates and which have been among the biggest beneficiaries of the AI investment theme.

"AI-related companies now account for a substantial share of market capitalization in several major equity markets, most notably the United States, but also in Emerging markets and Japan."