Ignore PEs, Watch Earnings: Janus Henderson Strategist on Market Drivers

Janus Henderson strategist Adam Hetts says investors should focus on earnings rather than price-to-earnings ratios to understand the current market rally. Speaking on Bloomberg Open Interest, Hetts argued that the market's advance is being driven by strong corporate earnings growth, not by multiple expansion. He noted that while AI stocks have captured attention, the rally is broadening beyond Big Tech into other sectors such as industrials, financials, and healthcare. Sticky inflation, in his view, is not a dealbreaker for equities as long as earnings continue to grow. This perspective aligns with the Fed model, which compares the earnings yield (the inverse of the P/E ratio) to the 10-year Treasury yield. Currently, the S&P 500 earnings yield stands around 4.5%, while the 10-year yield is near 4.2%, suggesting stocks are still reasonably valued relative to bonds. However, forward P/E multiples have expanded to 21x, above the 10-year average of 18x, indicating that further gains depend on earnings delivery.

For stock traders, this perspective suggests that the current environment favors a focus on earnings quality and sector diversification. The broadening of the rally implies that opportunities may exist outside the usual tech names, as breadth indicators like the percentage of stocks above their 200-day moving average have improved. Sector rotation is evident, with energy and materials benefiting from commodity price strength, while defensive sectors lag. Additionally, buyback yields remain elevated, with S&P 500 companies on track to repurchase over $1 trillion in shares this year, providing a floor for prices. Traders can track these moves on NowPrice's live stocks dashboard to identify which sectors are gaining momentum and monitor options-implied volatility, which has declined from pandemic highs, signaling reduced hedging demand.

Looking ahead, Hetts advises watching earnings reports across sectors for confirmation of the broadening trend. Key data points include forward earnings guidance and the earnings yield relative to Treasury yields, which can signal whether the rally has further room to run. If the earnings yield remains above the 10-year yield, stocks may continue to attract investors seeking income. Conversely, a sharp rise in bond yields could pressure valuations. Traders should also monitor the Cboe Volatility Index (VIX), currently around 14, for signs of complacency or stress. The upcoming earnings season will be critical to validate whether the broadening trend is sustainable or if it fades, with consensus expecting 10% earnings growth for the S&P 500 in 2025.