Capital markets have bifurcated with the US 10-year treasury yield trading at post-US election lows, while US equities have remained at record highs. Typically, when bond yields fall, the market has begun pricing in slower economic growth and a lower probability (or slower pace) of US Federal Reserve rate increases. At some point, the bifurcation will end and stock prices will correct lower in our view.
The S&P 500 is currently trading at 17.7x the forward 12-month earnings estimate. This price-to-earnings (P/E) ratio is above the 5-year average of 15.3x and the 10-year average of 14.0x according to FactSet. The chart below demonstrates that the change in corporate earnings estimates for the next 12-months (solid navy blue line) have not kept up with the change in the S&P 500 (dashed blue line), which corresponds to the rise in P/E multiple as price is rising faster than earnings.
The rising P/E multiples further underscores our view that valuations (and stocks) need to fall to support putting more cash to work in our equity portfolios. The cash levels in our equity portfolios remain relatively high with the Affinity portfolio at 56% cash and the Optima10 at 14.5% cash. While the higher cash positions have us lagging our benchmark thus far in 2017, we believe that being patient with our dry powder will protect capital and allow us to take advantage of more attractive valuations over the next few months.
The equity portfolios were negatively impacted by poor earnings from Michael Kors (KORS) and Chicago Bridge & Iron (CBI) in May. We continue to maintain our positions in both companies as their free-cash-flow yields remain over 10% and the worst of the negative earnings revisions is now likely behind us. These companies were not alone with poor earnings and guidance, as 75 S&P 500 companies have issue negative earnings per share (EPS) guidance for Q2/2017 versus just 37 companies that have issued positive EPS guidance according to FactSet.
An overview of the performance of our actively-managed products is as follows:
As of May 31, 2017. All figures are net of fees and other expenses. Past performance is not indicative of future results. Refer to https://www.afinacapital.com/legal/ for full details and disclosures.
(1) The benchmark represents a 50% weighting of the S&P 500 Total Return Index in Canadian dollars and a 50% weighting of the S&P/TSX Composite Total Return Index in Canadian dollars.