Profits at $1 Trillion Meet Valuations as S&P 500 RalliesWhitney Kisling and Lu Wang
With 72 percent of corporate earnings exceeding analysts’ estimates, it may be difficult for U.S. stocks not to reach a record in 2013.
The Standard & Poor’s 500 Index is 5.1 percent below the all-time high in October 2007. Profits in the benchmark gauge are forecast to exceed $1 trillion this year, or 31 percent more than when the gauge peaked, according to more than 11,000 analyst estimates compiled by Bloomberg. Even if the price-earnings ratio, now 9.8 percent below the six-decade mean, doesn’t expand, the S&P 500 is poised to recover fully from the financial crisis that began almost six years ago.
Last week, the S&P 500 hit a five-year high as 48 of the 67 companies that reported results exceeded analyst estimates in the biggest expansion in profits since the technology bubble of the 1990s. While bears say the rally will stall when forecasts prove too high, bulls say U.S. companies generating more income than ever will push stocks to new records.
“Corporate America has done an incredible job post-recession,” Leo Grohowski, BNY Mellon Wealth Management’s New York-based chief investment officer said in a Jan. 16 phone interview. His firm oversees $179 billion. “It’s not going to be a return to the ’80s and ’90s where we had people retiring from their day jobs to become day traders. I wouldn’t revert to the historic P/E ratio kind of environment. But the good news is I don’t think we need that to reach a record.”
The S&P 500 rose 1 percent last week to 1,485.98, the highest level since December 2007 as earnings from Goldman Sachs Group Inc. and BlackRock Inc. to Parker Hannifin Corp. and General Electric Co. beat analyst estimates and a report showed builders broke ground on more houses than forecast in December, capping the best year for the industry since 2008. The index has gained 4.1 percent in 2013 after advancing 13 percent in 2012. It slipped 0.2 percent at 10:07 a.m. in New York today.
Individuals added $3.1 billion to U.S. stock mutual funds in the first week of this year, the most since at least 2000, after withdrawing almost $250 billion in the past four years, according to data from research firm EPFR Global, scarred by the 2008 financial crisis that wiped out $11 trillion in market value.
Laszlo Birinyi, among the first money managers to advise buying U.S. stocks four years ago as the market bottomed, is so confident individuals are coming back that he bought options that pay should the S&P 500 climb 8 percent this year. He said the rally that has lifted equities more than 100 percent is entering a final phase when investors who had previously shunned stocks are finally forced to capitulate and buy shares.
“This is where the fireworks begin,” Birinyi, the president of Birinyi Associates Inc. in Westport, Connecticut, said during the Bloomberg Global Markets Summit in New York on Jan. 17. “The last phase of the bull market is very strong.”
Analysts predict S&P 500 earnings from 3M Co. to Walt Disney Co. and United Parcel Service Inc. will rise 8 percent this year to a record $110.10 a share, according to estimates compiled by Bloomberg. That implies a level of about 1,630 for the index based on today’s multiple of 14.8. Total net income in 2013 will be about $241 billion more than in 2007, even after profits had their biggest drop on record in 2008.
S&P 500 valuations have averaged 16.4 times income since 1954 and were 17.5 when the benchmark gauge for American equity hit a record 1,565.15 on Oct. 9, 2007, data compiled by Bloomberg show. The price-earnings ratio reached 33 during the peak of the Internet bubble in 2000, when earnings were $54.82 a share, according to the data.
“Right now we’re almost double those earnings, yet we are one half the multiple,” Chris Hyzy, who helps oversee about $325 billion as chief investment officer of U.S. Trust in New York, said in a Jan. 16 phone interview. “That to me is a market that is ripe for a new business cycle to come in, and to have a market that tracks profit growth.”
Earnings have bounced back faster than the economy as executives focused on cutting costs and took advantage of record-low borrowing rates. Corporate profits in the 12 months ended July 1 represented about 11 percent of U.S. gross domestic product, according to data compiled by the Federal Reserve. That’s the highest since the data began in 1947 and compares with 9.2 percent in 2007.
Corporations flocked to bond sales, driving issuance to a record $1.47 trillion last year, data compiled by Bloomberg show. Yields on debentures from the most creditworthy to the riskiest companies reached an unprecedented low of 3.53 percent last week, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.
“You’re starting from a better fundamental base now, and one that is driven by non-levered economic growth versus 2007,” Wayne Lin, a money manager at Baltimore-based Legg Mason Inc., said in a Jan. 17 phone interview. His firm oversees $648 billion. “That is a big difference between 2007 and today.”
American companies comprise a greater share of the 500 biggest stocks by market value as income expands faster than the rest of the world. U.S. corporations led by Apple Inc. and Exxon Mobil Corp. accounted for 168 of the top 500 companies at the end of 2012, up from 157 five years ago. Their profits as a percentage of the total income rose to 36 percent from 32 percent, data compiled by Bloomberg show.
S&P 500 earnings will exceed $120 a share by next year, double the level in 2008, according to analyst estimates. That’s the biggest increase since the 142 percent gain amid the technology boom from 1993 to 1999.
Growth in profits is slowing after a three-year increase and the market won’t reach a record unless multiples expand, according to Joseph Tanious, a New York-based global market strategist for JPMorgan Funds, which oversees $400 billion. Strategists at Tanious’s firm predict S&P 500 companies will earn $106 to $108 a share this year.
“Consensus estimates are still too high and need to come down,” Tanious said in a phone interview on Jan. 16. “Companies have trimmed all of their fat that they can trim. The big question we have here isn’t so much with earnings, it’s more so with multiple expansion.”
The index will climb 8.1 percent this year to 1,541, or 1.5 percent below the 2007 peak, according to the average of 15 Wall Street strategist estimates tracked by Bloomberg. Eight of them expect the index to surpass 1,565.15.
CEOs boosted income by cutting jobs and costs, driving profitability to record highs. They were also supported by the Federal Reserve, which pledged more bond purchases last year after injecting $2.3 trillion into the financial system and holding the benchmark rate at near zero since December 2008.
Profit margins climbed to 9.1 percent in September 2011, the highest level in at least 18 years, according to data compiled by Bloomberg on non-financial companies in the S&P 500. While the expansion helped boost earnings amid the slowest recovery from a recession since World War II, it’s unlikely to continue to push earnings higher, Tanious said.
Earnings growth averaged 3.6 percent per quarter in 2012, compared with 28 percent the previous two years, data compiled by Bloomberg show. Income shrank 1.3 percent in 2007 and expanded 16 percent on average for the four years preceding a profit contraction that lasted nine quarters, as the S&P 500 tumbled 57 percent in the financial crisis.
The U.S. economy will expand 2.8 percent next year, up from the 2 percent forecast for 2013 and greater than the 1.9 percent in 2007, according to 83 economists surveyed by Bloomberg.
3M, Apple and 82 other S&P 500 companies are scheduled to report earnings this week. 3M, based in St. Paul, Minnesota, is forecast to earn a record $6.85 a share this year. Shares of the manufacturer of products from Ace bandages to dental braces reached an all-time high of $98.75 on Jan. 18. The stock will climb to $103.47 over the next 12 months, according to the average of 15 analyst estimates compiled by Bloomberg.
Disney’s earnings will rise 11 percent in fiscal 2013, according to the average projection. The world’s largest entertainment company trades at 17 times reported earnings, a 43 percent discount to three-decade average. Reaching analyst projections would send the stock to a new high of $55.96.
United Parcel Service, the world’s biggest package-delivery company, would reach more than $91 a share if the stock’s multiple stays at today’s 17.9 and the Atlanta-based company matches analyst earnings projections of $5.13 a share this year, data compiled by Bloomberg show. The stock, which rose to $80.25 last week, has never traded above $90.
The S&P 500 took about 25 years to reach a new high after the Great Depression and since then, it has taken three years on average for the index to surpass previous records, according to data compiled by Bloomberg. It’s been more than five years since the October 2007 high. The S&P 500 took about seven years in the 1970s and 2000s to exceed old highs.
“We have just had the strongest inflows into equity funds since 2000, the economy continues to heal and the retail investor is finally paying attention,” said Howard Ward, the chief investment officer for growth equities at Gamco Investors Inc., which oversees about $37 billion. “I would be surprised if the S&P 500 did not hit a new high this year.”