Fundamental analysis of the earnings and economic outlook is traditionally the number one skill for asset allocation. But following the global financial crisis (GFC), the Fed and other central banks have turned to non-conventional asset purchasing programs for conducting monetary policy. Central bank policy actions have been the most powerful driving force for risk assets in the past 10 years. 2019 was a notable year, reminding investors that fundamental indicators could go south but stocks could nevertheless climb because of a central bank liquidity-driven price-to-earnings (P/E) expansion.
Setting aside the potential noise of forward estimates in these crazy COVID times, the equity rebound from the March lows has magnified the role of P/E re-rating. Gauging S&P 500 valuation through forward P/E, it’s starting to look on the richer side (Chart 1). However, with policy response (buying of corporate bonds), coupled with zero interest rates and the potential for gradual re-opening of the U.S. economy in May, valuation and stock prices could rise further on modest good news.