Many clients have asked me about whether the recent market sell-off has gone too far? The more relevant question is, have Price-Earnings (P/E) ratio’s contracted too far? To answer this question, the reader must first understand what a P/E ratio is and how it is interpreted. Definition per Investopedia, “the price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple.” The various market indices can be tracked as an amalgamation of their components P/E’s and trade based on either a forward-looking or 12-month trailing P/E multiple. Whenever you hear an analyst make an opinion of value of a particular market-index, they are normally making a statement about the P/E of a particular market based on it’s forward or forecasted earnings expectations. The average forward-looking P/E of the S&P 500 Index is fairly valued at an average of about 16.7x forecasted earnings. The S&P 500 P/E Ratio Forward Estimate is at a current level of 16.43x earnings, down from 16.90x earnings last quarter and down from 18.67x earnings one year ago. This is a change of -2.80% from last quarter and -12.00% from one year ago.
Most analysts might state that since the sell-off, valuations of the companies within the S&P 500 Index have come down significantly from their all-time highs and there might be an opportunity to obtain below average values during this period of multiple contraction. However, there has been as significant amount of debt added to the capital structures of companies in the recent years during record low-levels of market interest rates. As of June 2018, and S&P Global survey reported “U.S. companies have reached a record $6.3 trillion in corporate debt and the riskier borrowers are more leveraged then they were in 2007.” Although, the companies within the S&P 500 have over $2 trillion of cash on their balance sheet to service this debt, one might make the argument that the increased use of leverage in the late-cycle might weigh more heavily on the value of P/E multiples moving forward. The use of leverage helps enhance return on equity and improve corporate profits during expansionary periods of forecasted earnings. Heck, even if corporations are using the proceeds from debt to finance share buyback programs, this would have a positive impact on P/E multiples. I am concerned about the 3rd quarter decline of business spending and investment that was reported on the 3rd quarter GDP 3.5% growth rate. However, during this earnings season, we cannot deny that both institutional and retail investors have been highly concerned about slowing growth for forward-looking guidance on revenue and earnings.
When considering whether the recent sell-off in the market has been overdone and P/E multiples are more attractive, I would caution investors to look deeper into the earnings reports and assess how increased debt levels will impact earnings if growth forecasts continue to deteriorate. Perhaps, one might consider the average P/E ratio of the S&P 500 Index, adjusted for reduced sales growth and profit growth with higher leverage use as the new bar to be fairly-valued. Then, consider how much further down we must sell-off to reach that bar. With that said, we urge our readers to redress their equity exposure and make sure that their portfolio equity/bond/hedged investment allocation is in line with their risk number. Know your risk number!
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Why is it important to keep track of U.S. Treasury interest rate levels? How do they impact interest rates globally?
It is important because the U.S. Treasury yield curve is the first mover of all domestic interest rates and the most influential factor in setting global interest rates. Interest rates on all domestic bond categories rise and fall based on the yield activity within the U.S. Treasury market. In general, investors view the US. Treasury security as the risk-free rate, or least risky security in the global markets. Investors use the Treasury yield-curve (yields for treasuries at all maturities) as an acceptable yield-for-risk benchmark for all bond investments at higher risk levels.
How does the Federal Reserve influence the direction and activity of the yield curve?
The Federal Reserve directly affects the short-term side of the yield curve by setting the Federal Funds Rate. The Fed Funds rate is the rate at which banks charge each to lend capital to each other during the overnight cycle. The Federal Reserve also controls the prices of treasuries and other bonds in the market by their open market operations that purchase and sell of bonds by increasing the supply of bonds or reducing the supply of bonds in the market place. This process is called quantitative easing or tightening. At this moment, the Federal Reserve is in the process of tightening monetary policy, which is encouraging the U.S. treasury yield curve to rise and push up U.S. bond yields. This action is quite common in the later part of the economic-cycle after an extended period of economic growth and expansion. Please select the link below to review the current treasury yield environment and U.S. credit yield environment.
How is the Federal Reserve rate policy different then other central bank around the globe?
In developing nations, such as the European Union, Japan, and Australia, the central banks are working cohesively to loosen monetary policy and encourage a relatively low interest rate environment. The European Central Bank, Central Bank of Japan, and others have been engaged in hyper quantitative easing operations to bring the key overnight lending rate into negative territories with the intent to discourage investing into their government bonds and encourage the market to invest into higher risk assets. (Such as stocks, corporate bond, private equity, etc.) The primary motive is that the developed market economies have struggled to produce substantial and prolonged periods of economic growth and expansion. The difference between the progress of the U.S. and Developed-International economic cycles has been a thematic concern for monetary policy makers. This concern has resulted in a divergence of global rate policies amongst global central banks and substantial difference in the price of bonds yields around the world that can be observed rather easily. Select the link below to view developed-international market interest rates globally.
If you receive an IRS notice, you should request that the IRS remove the penalties for reasonable cause and for first time penalty abatement. We usually do this while paying the undisputed amount of income tax and interest.
Penalties during an audit
I would not agree to penalties during an audit, especially if the taxpayer had a good history. Do not agree to an audit report that includes penalties. If you have already agreed to penalties, you could re-open the audit.
UPDATE: OPKO scheduled to resume trading Friday at 1:15 p.m. EDT.
Opko Health Inc.’s stock closed down 18% on September 7, 2018. Importantly, Nasdaq halted trading in Opko Health, NASDAQ symbol OPK ($OPK) on September 7, 2018 at 14:34:38 Eastern Time at a last sale price of $4.5835. Meanwhile, nasdaq suspended trading since that time. While this has transpired, hurricane florence bears down on the United States.
Equity Options in OPK
Importantly, September 14, 2018 options are set to expire. The Options Clearing Corporation handles options clearing. The OCC issued a notice #43635 regarding equity option expiration on September 11, 2018. Furthermore, the memo indicates that so long as trading is suspended, equity options in $OPK will not automatically exercise even if they are in the money. Importantly, the holder must provide positive exercise instructions to OCC. If trading resumes, then the options will exercise, as normal.
In the money Options
There are several in the money options relating to OPK. The Sept 14 $5.00 put says it appreciated by 650%. See OPK180914P00005000 and OPK180914P00005500.
The Message from OCC
Thank you for using our services. There are a few OCC memos which will help. Hence, the general guidelines memo when a stock halts: