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Nasdaq Stands Its Ground. Two of the three major U.S. indexes were unable to sustain early gains and closed in the red, with only the Nasdaq Composite ending in positive territory on Monday. The rally of Chinese stocks didn’t seem to affect how investors view the U.S. market, where many start to worry about the peak earnings and hence slower growth going forward. In today’s After the Bell, we…
S&P 500 Is the Final Holdout. Will It Succumb?
The
S&P 500
saw its fourth consecutive day of declines Monday, effectively wiping out most of its recent recovery. The large-cap index dropped 12 points, or 0.4% to close at 2755.9, while the
Dow Jones Industrial Average
slipped 126.93 points, or 0.5%, to reach 25,317.41, and the
Nasdaq Composite
gained 0.26% to hit 7468.63.
The indecisiveness of the market leaves many investors wondering what the next move might be, but Morgan Stanley strategist Michael Wilson doesn’t have good news. “We think attempts to rebound were more short lived than sustainable,” Wilson wrote in a note on Monday.
Many analysts have noted different sections of the market are feeling the claws of the bear. Growth stocks — the bull market’s darlings — are the latest victims. The last round was particularly painful as large amounts of assets were exposed to those stocks.
Declines have now hit virtually every major asset class, according to Wilson, all of which — except for the S&P 500 — are lagging the consumer price index’s growth year to date. Wilson believes the stalwart S&P 500 will be the next target. “To the chagrin of many, we think the S&P will eventually succumb, too, and probably soon,” Wilson wrote.
One of the worries many investors have is the possible peak of earnings and hence the decline of stock valuation from here onward. The S&P 500 is currently trading at 16 times forward earnings. This level could prove to be a ceiling instead of floor, according to Wilson.
The equity-risk premium — how much excessive return investors require to compensate equity risks — plays a key role in estimating the stock market’s forward valuation, as it reflects how much risk investors see in the market and how optimistic they are about the future.
Calculated as the S&P 500’s 12-month forward earnings yield minus the 10-year Treasury yield, the risk premium hit its lowest level since 2008 on Jan. 26 this year, according to Wilson, indicating investors were in an extreme “risk-on” mode. He thinks that low risk premium was supported by many tailwinds in the economy that time, with the tax cuts just starting to show on the balance sheets, financial conditions still easy with accommodative rates, trade risks still unclear and remote, and inflation cost still manageable.
But things are different now. “As we move later in the cycle and see these tailwinds all turn around, we struggle to see any scenario that will be as supportive of risks assets and sentiment going forward,” he wrote.
If the bond rates declined, there would be concerns about growth, given the Fed’s recent hawkish tilt. But if the rates kept rising, it could also be headwinds at this stage of the cycle, as investors worry about the Fed overshooting with rate hikes and triggering the next recession. Either way, investors’ risk premium is likely to rise and the stock market’s forward valuation will drop as a result.
The Hot Stock
Shares of
Jacobs Engineering
(JEC) shot to the top of the S&P 500 Monday, on news it will sell a segment.
Jacobs Engineering rose $4.92, or 6.8%, to $77.21.
The company agreed to sell its Energy, Chemicals and Resources segment to Australia’s
WorleyParsons
(WYGPY) for $3.3 billion, including $2.6 billion in cash and $700 million in WorleyParsons shares, in a deal that values the unit at 11.5 times trailing 12-month adjusted earnings before interest, taxes, depreciation and amortization.
“While we like diverse ops and are not averse to energy exposure, we expect this transaction to be received very favorably by investors given continued wariness around engineering and construction energy exposure and attractive valuation for the divestment,” writes Keybanc’s Tahira Afzal, who reiterated an Overweight rating and $80 price target on the shares. “Our initial analysis suggests potential step up in value to the mid-$90s as investors reassess Jacob’s risk profile.”
Jacobs Engineering is up 17.1% year to date, and has risen 31.3% in the latest 12 months.
–Teresa Rivas
The Biggest Loser
Nektar Therapeutics
(NKTR) fell to the bottom of the index, following a cautious analyst note that points to monotherapy (a focus on a single treatment) gains at rivals drug makers.
Nektar lost $8.30, or 17.2%, to $39.89.
H. C. Wainwright analyst Debjit Chattopadhyay reiterated a Neutral rating on the shares, but warned that data presented by rival Roche (RHHBY) about its monotherapy activity at the European Society for Medical Oncology meeting could spell trouble for Nektar. He writes that Nektar’s NKTR-214 cancer drug had no monotherapy activity, and competition from Roche and
Eli Lilly
(LLY) could further complicate the outlook for Nektar, as well as potentially “compel Nektar’s partner
Bristol-Myers Squibb
(BMY) to re-evaluate the aggressive development strategy that was outlined earlier this year.”
Year to date, Nektar is down 33.2%, although it’s gained 65.1% in the latest 12 months.
–Teresa Rivas
Write to Evie Liu at [email protected]
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