Record Earnings Point to More Stock Market Gains

Record corporate profits and buying by individual investors may help extend a rally that has nearly doubled the Standard & Poor's 500-stock index since the market bottom in March 2009. Companies in the S&P 500 are expected to see their earnings for the preceding 12 months reach a record $91 a share by August, according to estimates compiled by S&P and Bloomberg.

If earnings reach that level, they would surpass the previous peak of $90 a share reached in 2007. 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. Profits didn't recoup their 67 percent tumble during the Great Depression until 19 years later.

While earnings growth will slow in the second half, stock purchases by investors who missed the rally will keep pushing prices up, according to the Leuthold Group in Minneapolis. "People are more comfortable with the recovery than at any time over the last couple of years," says Doug Ramsey, director of research at Leuthold, which recommended buying equities four days before the bull market started in March 2009. "That's typically when retail investors regain courage" and may spur an additional rise of as much as 25 percent in the S&P 500 during the next 18 months. Mutual funds that invest in U.S. equities 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.

Analysts disagree about whether the market is overvalued. Yale University economist Robert J. Shiller says U.S. equities are "expensive." The S&P 500's cyclically adjusted price-earnings ratio, a valuation measure Shiller popularized that is calculated by dividing the index's price by the average inflation-adjusted earnings during the past 10 years, is about 44 percent higher than the average since 1900.

Profits are being inflated by government attempts to stimulate the economy, and earnings will eventually "mean revert," says Rob Arnott, founder of Research Affiliates, which oversees $75 billion in Newport Beach, Calif. "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," he says.

Linda Duessel, equity market strategist at Federated Investors, which oversees $358 billion, believes government stimulus has achieved its goal of creating a self-sustaining recovery that will endure even after stimulus ends. "We see accelerating growth around the globe," says Duessel, who turned bullish on U.S. stocks at the beginning of 2009. "This market looks cheap to us."

The bottom line: The market has doubled since March 2009. Record earnings of $91 a share and buying by individuals may keep the rally going.

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