What are we to make of the current state of the stock markets and the fundamentals driving them?
Earnings growth expectations are weak, manufacturing activity is decelerating, the dollar is strengthening, commodity prices are deteriorating, and business spending is anemic.
Yet stocks have been rallying.
In a new research note titled “Remember The 80s?” Deutsche Bank’s David Bianco reminds us that these dynamics are not unprecedented.
“1967, 1985-86 and 1995 have the weakest economic mid-cycle manufacturing ISM since 1960,” he wrote.
“We see 1985-86 as very similar to now: a stronger dollar and weaker commodity prices, soft business spending and weak exports. This caused 1985-86 to have the weakest non recession EPS growth. Yet, the S&P delivered strong gains as its PE expanded from about 10x in 1984 to 15-17x by 1986 as investors became more trusting that inflation risks had dissipated and accepting of secularly lower interest.”
Check out how the PE surged during that period.
All of this speaks to the nature of the stock markets, which can often appear irrational.