The Standard & Poor’s 500 Index’s failure to keep pace with record corporate earnings may signal the benchmark equity gauge will surge if it returns to its historical relationship with profits.
The CHART OF THE DAY shows that four years ago, when the S&P 500 lagged behind trailing 12-month corporate profits, the measure went on to reach an all-time high of 1,565.15. The chart also shows that while combined earnings by companies in the index have exceeded the previous peak reached in 2007, the measure itself is 19 percent below that October 2007 record.
Companies have “increased efficiency, productivity and profit margins,” said David Goerz, the chief investment officer at Highmark Capital Management Inc., in a telephone interview yesterday. “That’s resulted in strong performances at a time when investors are very skeptical about the future. It’s not surprising that the market would be trading at a significant discount.” He said, “There’s a lot of upside for the U.S. equity market.”
The S&P 500 fell 7.5 percent from its high in April through yesterday as concern Europe’s debt crisis will trigger a recession overshadowed U.S. corporate profits that topped analysts’ estimates for 11 straight quarters. Out of 413 S&P 500 companies that reported results since Oct. 11, almost 75 percent have said profits exceeded forecasts, according to data compiled by Bloomberg.
Profit projections for 2011 of $99.10 suggest the S&P 500 will surge to 1,625 when compared with its six-decade historical price-earnings multiple of 16.4, the data show. Profits for S&P 500 companies are expected to climb an additional 10 percent in 2012 to $109.27, Bloomberg data show.
Investors have resisted buying equities because of this “strange idea of peak earnings,” according to San Francisco-based Goerz, whose firm oversees $17.2 billion. “Peak earnings don’t exist,” he said.