With the S&P 500 breaking 3,900 today, let's take a look at valuation.

First, when we entered earnings season, the expectation was for another deep decline in year-over-year earnings. 

Given that Q4 2019 registered a near record high on quarterly earnings for S&P 500 companies, the idea of beating such a number in Q4 2020 (in the midst of a Pandemic and a government throttled economy) wasn't even on Wall Street's radar. 

But we might get it. 

With about 85% of companies now reported, about 8 out of 10 have beat on estimates, and the change in earnings compared to Q4 of 2019 is now projecting a +3.6% growth.  That compares to what was expected to be a 9.3% contraction.

With that, if we look at the earnings projections for full year 2021, the forward P/E on stocks (the S&P 500) comes in around 22.  

That's well above the long run average P/E (ttm), which comes in around 16. 

But, we're not just in a low rate environment, we are in the extreme of all low rate environments — zero rates.  And historically, when the 10-year is below 3%, stocks tend to trade at a P/E north of 20.  Why? The low rate environment does what is intended to do, force people "out on the risk curve" (i.e. force them to accept additional risk in pursuit of higher required returns).  That means, out of bonds, and into stocks (which drives higher multiples).   

So, a forward P/E of 22 could still be cheap in this rate environment, especially with the Fed's aggressive QE program/stance.

But I suspect this multiple will become cheaper and cheaper, as we begin to step through 2021 earnings.   The full-year estimate for this year is looking for 23% earnings growth.  That number may be crushed. 

Remember, these companies will be reporting against a very, very low earnings base, especially from the first half of 2020.  As we know, corporate America always takes the opportunity to put all of the bad news on the table in a widespread crisis.  It's safe to say that any loss or writedown they could take, they took last year (when things were broadly very bad and uncertain).  That sets up for big growth in y-o-y earnings for 2021 – even bigger than Wall Street's full year estimate of 23% growth.  And a higher "E" in the P/E, drives down the valuation on the broad stock market.  

Bottom line:  Even at a forward P/E of 22, in this (global) rate environment, stocks may still be relatively cheap.  And it's likely that valuation will be getting cheaper, especially with more stimulus dollars coming down the pike to stoke economic growth.    

Yesterday we talked about China’s buying spree in commodities, repeating their post Global Financial Crisis strategy of building inventory in the world’s most important commodities, at cheap prices.

With that, oil prices have the perfect storm.  The new administration has vowed to kill the U.S. fossil fuels industry.  The global climate actioners have coordinated to choke off capital to new oil exploration projects (globally).  And China is buying oil around the globe at the fastest pace on record. 

This is a recipe for lower supply.  And demand is only growing, as the economic recovery picks up, despite the idea that we will all drive electic cars one day (it won’t be anytime soon).  Lower supply and higher demand means oil prices could move much higher, fast. 

This creates two problems:  1) higher energy prices will weigh on the economic recovery, and 2) higher energy prices will feed into the inflation data, which will force the Fed (and global central bankers) to get to work on reversing the ultra easy interest rate environment — which will then weigh on economic recovery.

Here’s a look at the chart of oil as we end the week.  

Biden made his first prepared foreign policy speech this afternoon.

Remember, the Trump administration spent the better part of four years fighting China's ascent to global economic superpower.  Trump waged the trade war with China, ultimately getting concessions through a "Phase 1" deal.  A month later, a global pandemic orginated from China.  And by mid-summer, Pompeo explicitly declared the Chinese Communist Party "the greatest threat to everyone in the free world." 

So, what did the new President have to say about China today in his first historic foreign policy speech?  Almost nothing. He positioned China as a cut-throat economic competitor.  Russia is the threat to democracy as it's told by the new adminstration. 

With that, as we've discussed in my daily notes, the CCP is the big winner in the American election.  China's leadership gets to go back to the business that got them so close (pre-Trump) to becoming the global economic superpower — ramping up the global supply chain and manipulating the currency to ensure they maintain global dominance in exporting. 

But, while they have been in a position of strength economically, relative to the rest of the world, over the past 12-months, China has focused on importing.  They've been stockpiling global commodities at dirt cheap prices, just as they did in the aftermath of the Global Financial Crisis.

China bought record volumes of crude oil, copper, iron ore and coal in 2020.  They also imported a record amount of corn, wheat and soybeans. 

So, that's record levels of industrial metals, energy and food.

What happened to commodity prices the last time China went on a commodities binge in a global recession (a decade ago)?  Prices spiked. 

Oil went from the low $30s back to north of $100, all while the U.S. economy was still suffering.