S&P marks three-year bull run
Seems like only yesterday that the horrific decline in U.S. equities was in full force. But here we are some three years later, looking at an S&P at 1366… 12 percent below intra day peak levels on March 24, 2000 at 1552 and 13 percent below intra day Oct. 11, 2007 levels at 1576. For some, it is “only” 11 percent to 13 percent below those peaks; for others, it is a reality of a lost decade as it is “still” below those peaks.
The S&P index is a capitalization weighted index of the 500 largest publicly traded U.S. stocks. The index also gives insight into the level of earnings expected for this elite group of companies and the multiple that the market participants collectively are willing to pay for those earnings. The index can also be looked at as the product of: the upcoming year’s consensus earnings for the companies comprising the
Safi S&P 500 (which consensus is an average of strategist/economist forecasts for earnings… whether good or bad in tt their forecasts) times the multiple that investors are willing to pay for those earnings.
The S&P at the beginning (to middle) of a new year is valued/stated on the current year forecasts (or “forward earnings”); at the end of a year, the S&P valuation is generally looking at the next year’s forecasts. So, right now (at the beginning of a new year), the focus is on consensus for earnings for 2012 and, at $107 in forecasted consensus earnings, the multiple being paid is 13 times (or the S&P’s current price level of 1366 divided by $107 equals 13).
Changes in the S&P value can imply either a change in consensus earnings or a change in multiple, or both. Which of the two (earnings or multiple) are more powerful in driving stock prices higher or lower? In my opinion, multiples are much more important; they reflect risk appetite.
Let’s consider the range of multiples implicitly assigned to consensus earnings for S&P equities in the past 25 years (in this case, we are looking at the past actual earnings to figure the multiples.)
The range in multiples was huge: a low 12-13 multiple in the late 1980s expanded to high 20s in both 1998 and 2000. You might recall euphoria in 1998 before the Long term Capital Funding collapse and in 2000 before the tech bust.
In a bull market there is generally a good fundamental story (growth in consensus earnings)… which is then translated into a turbo-charged multiple. Sure, earnings forecasts are rising, but multiples are often rising much faster.
Some might be surprised that the 2008-2009 bear market did not produce a multiple to S&P earnings lower than the current multiple. Yes, stocks tanked some 57 percent, but so did reported earnings… so much more so; the net result in 2009 was that historical multiples did not get as low as they are currently.
Do the swings in multiples really make sense? In a fundamental sense, not always; in a technical sense, yes, the swings reflect markets feeding on themselves, often establishing price trends. From my perspective, the big story behind the 1990 bull market was not the underlying positive fundamentals; rather, it was the willingness of the market participants to pay higher and higher multiples for the consensus earnings forecasts.
History is all well and good, but what about the now? It certainly seems as if it is more probable that multiples can expand from what is a 25-year low water mark and the bull can continue and S&P stocks have a dividend yield of 2 percent and increases expected this year versus the .3 percent yield for the two-year Treasury and .9 percent yield on five-year Treasuries. And that barely scratches the surface of reasons why the bull market can continue.
The concerns that some technical folks have is that the advance decline line (number of stocks advancing versus number retreating) and the Summation Index (a measure of stock market breadth) are not looking pretty; they look as if prices are going higher but with fewer stocks attending the bull market party. And, most previous bull markets — on average— have had difficulty getting past the 39-month mark; we are now at 36 months. But there is no end to what the central bankers can and are willing to do these days to keep the rally intact. ¦
— Jeannette Showalter, CFA is a commodities broker with Worldwide Futures Systems, (239) 571- 8896. For mid- week commentaries, write to firstname.lastname@example.org.
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