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Biggest Rise in Profits Since 1900 Sustains Rally After S&P 500's 97% Gain

The biggest increase in profits in more than a century is telling investors that this is no time to sell stocks, even after the Standard & Poor’s 500 Index rallied 97 percent.

S&P 500 earnings are poised to surpass the 2007 peak of $90 a share in the third quarter after surging from $7 in March 2009, the quickest recovery since at least 1900, according to data from S&P and Yale University’s Robert Shiller compiled by Bloomberg. The gap between projected 12-month profits and average earnings over the last 10 years is set to widen the most since 1951, the data show.

PNC Wealth Management, Federated Investors Inc. and ING Investment Management, which together oversee about $1 trillion, say consumer spending will sustain the recovery after government stimulus helped lift profits from the lowest level since the Great Depression. While earnings will slow in the second half, stock purchases by investors who missed the S&P 500’s advance will fuel gains, according to Leuthold Group LLC.

“People are more comfortable with the recovery than at any time over the last couple of years,” said Doug Ramsey, the Minneapolis-based director of research at Leuthold Group, which oversees $3.9 billion and recommended buying equities four days before the bull market started. “That’s typically when retail investors regain courage,” and may spur a rise of up to 25 percent in the S&P 500 during the next 18 months, he said.

Biggest Since 1937

The S&P 500 rose 1.4 percent to 1,332.41 last week, bringing its 2011 advance to 6 percent and putting it 0.8 percent away from this year’s high of 1,343.01 on Feb. 18. It slumped through March 16 following Japan’s record earthquake and civil unrest in the Middle East and northern Africa. The gauge’s gain since March 9, 2009, is the most over comparable periods since 1937, according to S&P’s Howard Silverblatt. The index climbed less than 0.1 percent at 4 p.m. in New York today.

Shares haven’t kept up with earnings. S&P 500 companies’ 12-month profits are projected to reach a record $91 a share by August, according to estimates compiled by S&P and Bloomberg. That would be the highest-ever level on an inflation-adjusted basis and up almost 13-fold from their low two years ago, S&P and Shiller data compiled by Bloomberg show.

Rebound in Profits

The 50-month rebound in profits, following a 92 percent drop during the global financial crisis, would be faster than the 52 months it took to recover from the bursting of the dot- com bubble in 2000, when earnings fell 55 percent, the data show. Profits didn’t recoup their 67 percent tumble during the Great Depression until 19 years later.

American International Group Inc. (AIG), the New York-based insurer bailed out by U.S. taxpayers, has posted the biggest turnaround since March 2009. AIG swung from a trailing 12-month loss of $95.8 billion to net income of $7.79 billion, according to data compiled by Bloomberg.

ConocoPhillips in Houston earned $11.4 billion last year after losing $20.3 billion in the 12 months through March 2009, the data show. The third-largest U.S. oil company may report a 22 percent gain in first-quarter net income and a 9 percent decrease for all of 2011, analysts’ estimates compiled by Bloomberg show.

Apple Inc. (AAPL) has boosted net income to $16.6 billion from $7.25 billion in March 2009. The Cupertino, California-based maker of iPads is projected to grow net income 54 percent in its fiscal year ending in September, data compiled by Bloomberg show. Apple is set to report second-quarter results on April 20.

Earnings Season

AIG shares have surged 497 percent since March 9, 2009, while Apple jumped 315 percent and ConocoPhillips (COP) rallied 118 percent. Alcoa Inc. (AA), which rebounded 224 percent, starts the earnings reporting season on April 11. The New York-based aluminum producer may post a 268 percent increase in first- quarter net income, according to the average of five analyst estimates compiled by Bloomberg.

The S&P 500 trades for 13.7 times estimated 2011 earnings, compared with an average of 15.7 times reported annual profit since 1900, Shiller data compiled by Bloomberg show.

Earnings for the measure will total $95.21 this year, according to S&P’s estimate when adjusted for inflation using the median economist projection for the consumer price index in a Bloomberg survey. If that forecast is met and the 12-month price-earnings multiple climbs to its mean since 1900, the S&P 500 would rise 12 percent to end December at 1,494, or 4.7 percent away from its record of 1,565.15 on Oct. 9, 2007.

Analysts’ Forecasts

S&P 500 profit has topped analysts’ average forecasts eight straight quarters, according to data compiled by Bloomberg. Inflation-adjusted profits for the index will climb 22 percent in 2011, estimates compiled by S&P and Bloomberg show.

Shiller, whose book “Irrational Exuberance” foreshadowed the end of the 1990s surge in stocks, said in an interview that U.S. equities are “expensive.” The S&P 500’s cyclically adjusted price-earnings ratio, a valuation measure popularized by Shiller that is calculated by dividing the index’s price by the average inflation-adjusted earnings during the past 10 years, is 41 percent higher than the average since 1900.

“I view current market conditions as a great opportunity to take risk off the table,” said Rob Arnott, founder of Research Affiliates LLC, which oversees $75 billion in Newport Beach, California. “When markets are expensive, you’re better off letting somebody else bear the risk to pick up that last nickel in front of the steamroller.”

Stimulate the Economy

Profits are being inflated by government attempts to stimulate the economy that won’t last, and earnings will eventually “mean revert,” or fall back toward average levels, according to Arnott, who prefers emerging-market bonds and short-term corporate debt.

The Federal Reserve has kept its benchmark interest rate at a record low near zero since December 2008. Federal government spending accounted for about 24 percent of gross domestic product last year, within 2 percentage points of the highest level since 1945. The budget gap widened to a record $222.5 billion in February.

Should earnings match analysts’ forecasts next quarter, they’ll be about 59 percent higher than the 10-year average. The only other times since 1951 that the gap approached that level was in December 2006 and August 2000, near the peaks of U.S. profit and economic expansions, data compiled by Bloomberg show.

That won’t kill the rally, said E. William Stone, who predicted the 2009 gain in stocks and helps oversee about $108 billion as the Philadelphia-based chief investment strategist at PNC Wealth Management.

Economic Data

U.S. economic data are surpassing expectations this year by the most since 2004, based on the average level of Citigroup Inc.’s Economic Surprise Index, a gauge of how much reports are exceeding economist estimates in Bloomberg News surveys.

“Evidence is building that we have a self-sustaining recovery,” said Stone. “There are corporate profits. There’s the fact that consumer spending is there. Things are getting better.”

U.S. consumer purchases rose more than forecast in February, while a Labor Department report on April 1 showed employers created more jobs than estimated in March and the unemployment rate fell to a two-year low of 8.8 percent.

The world economy will probably expand 4.4 percent this year and 4.5 percent in 2012, according to January forecasts from the Washington-based International Monetary Fund.

Private Demand

Private demand may spur growth after more than $12 trillion pumped into the financial system by governments and central banks lifted the global economy out of its first contraction since World War II, according to Linda Duessel, the equity market strategist at Federated Investors, which oversees $358.2 billion.

“We see accelerating growth around the globe,”Duessel, who turned bullish on U.S. stocks at the beginning of 2009, said in an interview from Pittsburgh. “That helps to continue to propel earnings. This market looks cheap to us.”

Sixty-six percent of S&P 500 companies that have reported results topped sales forecasts last quarter, up from 62 percent in the previous period, a sign that demand may take over from cost cutting as a driver of profits, according to data compiled by Bloomberg.

Revenue has “surprised to the upside in these last several quarters,” Duessel said. “Sales are going to be propelled by employment.”

Buybacks, Dividends

The recovery in demand is spurring executives to spend the record $940 billion in cash they built up after the financial crisis. S&P 500 companies authorized 38 percent more buybacks in 2011 than a year earlier and dividends may increase to a record $31.07 a share in 2013, data compiled by Birinyi Associates Inc. and Bloomberg show.

That’s boosting confidence among mutual fund investors who sold shares during most of the bull market. U.S. equity funds attracted about $12 billion of inflows since December, compared with $134 billion of redemptions during the previous six quarters, according to Investment Company Institute data compiled by Bloomberg.

Individual investors “are way underweight equities,” said Paul Zemsky, the New York-based head of asset allocation for ING Investment Management, which oversees $550 billion and boosted stock holdings in April 2009. “The market is nowhere even close to being priced to perfection.”

To contact the reporters on this story: Rita Nazareth in New York at rnazareth@bloomberg.net; Michael Patterson in London at mpatterson10@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Gavin Serkin at gserkin@bloomberg.net

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