Posts tagged ‘S&P 500 earnings’
Stretching Rubber Band Creating More Value
Concerns over debt ceiling negotiations, European financial challenges, and overall economic malaise has reached a feverish pitch in the U.S., yet in the background, a valuation rubber band has quietly been stretching to ever more attractive levels. Regardless of whether seniors might not receive Social Security checks, troops not obtain ammunition, and investors not collect credit rating agency love, corporations keep churning profits out like they are going out of style (17%+ growth in 2011 estimated earnings). We have barely scratched the surface on earnings season, and I’m sure better than expected earnings from the likes of Google Inc. (GOOG), JPMorgan Chase & Co. (JPM), FedEx Corp. (FDX), Nike Inc. (NKE), and Bed Bath & Beyond Inc. (BBBY) will not sway the bears, but in the meantime profits keep chugging along. Although profits have more than doubled in the last 12 years, not to mention a halving in interest rates (10-year Treasury yield cut from 6% to about 3%), yet the S&P 500 is still down approximately -4% (June 1999 – June 2011).
What Gives?
Could the valuation stretching continue as earnings continue to grind higher? Absolutely. Just because prices have been chopped in half, doesn’t mean they can’t go lower. From 1966 – 1982 the Dow Jones Industrial index traded at around 800 and P/E multiples contracted to single digits. That rubber band eventually snapped and the index catapulted 17-fold from 800 to almost 14,000 in 25 years. Even though equities have struggled in the 21st century, a few things have changed from the low-point reached about 30 years ago. For starters, we have not hit an inflation rate of 15% or a Federal Funds rate of 20% (4% and 0% today, respectively), so we have a tad bit more headroom before the single digit P/E apocalypse descends upon us. If you listen to Peter Lynch, investor extraordinaire, his “Rule of 20” states a market equilibrium P/E ratio should equal 20 minus the inflation rate. This rule would imply an equilibrium P/E ratio of 16-17 when the current 2011 P/E multiple implies a value slightly above 13 times earnings. The bears may claim victory if the earnings denominator collapses, but if earnings, on the contrary, continue coming in better than expected, then the sun might break through the clouds in the form of significant price appreciation.
Another change that has occurred since the days of Cabbage Patch dolls has been the opening floodgates of globalization. The technology revolution has accelerated the flattening of the globe, which has created numerous new opportunities and threats. Creating a company like Facebook with about 750 million users and an estimated value of $80 billion to $100 billion couldn’t happen 30 years ago, but on the flip side, our country is also competing with billions of motivated brains lurking in the far reaches of the world with a singular focus of sucking away our jobs, resources, and dollars. Winners recognize this threat and are currently adapting. Losers blind to this trend remain busy digging their own graves.
Future is Uncertain
As famous Jedi Master Yoda aptly identified, “Always in motion is the future.” The future is always uncertain, and if it wasn’t, I would be on my private island drinking umbrella drinks all day. With undecided debt ceiling negotiations occurring over the next few weeks, political rhetoric will be blaring and traders will be hyperventilating with defibrillator paddles close at hand. If history is a guide, stupid decisions may be made, but the almighty financial markets (and maybe a few Molotov cocktails at a local protest rally) will eventually slap politicians in the face to wake up to reality. Perhaps you recall the attention the markets earned from legislators when the Dow fell 777 points in a single September 2008 trading session. Blood on the streets forced Congress to approve the Troubled Asset Relief Program hot potato four days after the initial vote failed. And if that wasn’t a gentle enough reminder for Democrats and Republicans, then a few lessons can be learned from the interest rate sledgehammer that capital markets vigilantes have slammed on the Greeks (10-year Greek yields are hovering above 17%+).
Down but Not Out
The stories of debt collapse, hyperinflation, double-dip recessions, plunging dollar, secular bear markets, and government shutdowns are all plausible but remote scenarios. As Winston Churchill so eloquently stated, “You can always count on Americans to do the right thing – after they’ve tried everything else.” Voter moods are so venomous that if fiscal irresponsibility is not changed, politicians will be voted straight out of office – even hardcore, extremist elected officials understand this self-serving point.
Suffice it to say, as the political noise reaches a deafening pitch in the coming weeks and months, a quiet rubber band in the background keeps stretching. When the political noise dies down, you may just hear a noise snapping stock prices higher.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Performance data from Morningstar.com. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, GOOG, and FDX, but at the time of publishing SCM had no direct position in JPM, NKE, BBBY, Facebook, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
September Surge: Stop, Go, or Proceed Cautiously?
The stock market just posted its strongest September and third quarter performance in more than seven decades (S&P 500 +8.8% and +10.7%, respectively), yet people are still waiting for a clear green light to signal blue investment skies ahead. Well of course, once it is apparent to everyone that the economy is obviously back on track, the opportunities persisting today will either be gone or vastly diminished. I’m not a blind optimist, but a sober realist that understands, like Warren Buffett, that it pays to “buy fear and sell greed.” And fear is exactly what we are witnessing today. The $2.6 trillion sitting in CDs earning a horrendously low 1% is simple proof (Huffington Post).
Like the fresh memory of a recent hand burned on the stove, the broader general public is still feeling the pain and recovering from the financial crisis. Each gloomy real estate or unemployment headline triggers agonizing flashbacks (read Unemployment Hypochondria) of the 2008-2009 financial collapse and leads to harmful emotional investment decisions. However, for some of us finance geeks that have cut through the monotony of “pessimism porn” blasted over the airwaves, we have discovered plenty of positive leading economic indicators bubbling up below the surface, like the following:
- Continued Economic Growth: Gross Domestic Product (GDP) grew +1.7% in the second quarter and current estimates stand in the +2.0% to +2.5% range for third quarter GDP, which will mark the fifth consecutive quarter of growth.
- Growing Corporate Profits: S&P 500 earnings are estimated to expand by +45.6% in 2010 and are estimated to grow by another +15% or so next year (Standard & Poor’s September 2010).
- Escalating M&A: Mergers and acquisitions activity increased to $566.5 billion in the third quarter. The value of announced transactions is up +60% from a year ago according to Bloomberg. If you have a tough time comprehending the pickup in M&A, then take a peek here.
- Record Cash Piles: The top 1,000 largest global corporations held a whopping $2.87 trillion in cash (Bloomberg).
- Accelerating Share Buybacks: Share buybacks totaled $77.6 billion in the second quarter, up +221% from a record low last year – Barron’s).
- Dividends Galore: S&P 500 companies have lifted their payouts by $15 billion so far this year versus a reduction of $40 billion for the same period last year (The Wall Street Journal). Tech giant Cisco Systems Inc. (CSCO) announced the pending initiation of a dividend, while Microsoft Corp. (MSFT) increased its dividend by a significant +23%.
I’m not naïve enough to believe choppy waters will disappear for good, but despite the depressing headlines there are constructive undercurrents. Beyond the points above, equity market prices remain attractive relative to the broader fixed-income markets (see Bubblicious Bonds) . More specifically, the S&P 500 is priced at about a 25% discount to historic valuation averages over the last 55 years (currently trading at about 12.5 Price/Earnings ratio vs 16.5x historic Price/Earnings ratio – Bloomberg). Now may not be the time to recklessly run a red light, but if you fearfully remain halted in front of the green light then prepare to receive a pricey ticket.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and CSCO, but at the time of publishing SCM had no direct position in MSFT, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Earnings Showing Speedy Growth
With approximately 2/3 of the S&P 500 companies reporting, Thomson Reuters is reporting not only are 78% of those companies beating analyst expectations, but they are also beating them by a large margin (~16%). The financial sector is still rather volatile and is distorting comparisons, but if you look at the non-financial sector, profit growth is on pace to grow +35% this quarter as compared to +18% last quarter. Earnings are not the only thing growing…so are revenues. After four quarters of revenue declines, sales are on track to rise +11% this quarter (versus +8% last quarter) thanks to almost 80% of the S&P 500 companies reporting revenue growth (rather than declines) in the first quarter of 2010.
Source: The Wall Street Journal
Signs of Employment Improvement
Unemployment at 9.7% remains stubbornly high, but with corporation’s newfound revenue growth, there are signs companies are becoming more confident in the hiring department as well. Typically the sequence of a business cycle follows the pattern of cutting expenses and increasing layoffs into a recession; building cash at the cycle trough while running leaner expenses and staff; improving productivity with capital expenditures and technology purchases before hiring; and then as the recovery firms up, companies enjoy widening margins with sales growth, resulting in the confidence to hire. Take for example JP Morgan (JPM) mentioned they plan to hire 9,000 workers in the U.S. this year and Intel (INTC) another 1,000 new positions.
Growth is Global
With all the headlines about Greece’s financial woes, one might underestimate the recovery abroad as well. The average earnings growth rate estimates for the G6 stock markets is +41.6% and +21.9% for 2010 and 2011 according to Ed Yardeni, but a majority of the growth is not coming from the Euro zone.
There is still no shortage of issues to worry about, assuming we understand a Utopia does not exist. Besides elevated unemployment, other issues to remain concerned about include: a lack of credit accessibility for small and medium businesses; massive government debt and deficits; and diminishing impacts in the coming quarters from government stimulus and Federal Reserve monetary stimulus.
Regardless of the nervousness, evidence continues to build for a continuation of better than expected earnings. The music will not last forever and eventual stop, but until then, our economy will enjoy the speedier than anticipated earnings growth recovery.
Read Whole Wall Street Journal Article on Earnings (Subscription)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in JPM, INTC, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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