Multiples Grow at Fastest Pace Since Dot-Com BubbleInyoung Hwang and Alexis Xydias
Price gains of stocks in the Standard & Poor’s 500 Index are outpacing profits by the fastest rate in 14 years as the bull market extends beyond the average length of rallies since Harry S. Truman was president.
The benchmark gauge for U.S. equities has risen 14 percent relative to income over the past 12 months to 16 times earnings, according to data compiled by Bloomberg. Valuations last climbed this fast in the final year of the 1990s technology bubble, just before the index began a 49 percent tumble. The rally that started in March 2009 has now outlasted the average gain since 1946, the data show.
Bears say the failure of earnings to keep up with prices signals the bull market is in its last stages, as companies from Caterpillar Inc. and Danaher Corp. forecast slower profit growth and the Federal Reserve prepares to reduce stimulus. Optimists point to expanding multiples as proof individual investors are growing confident enough in the economy to return to stocks. History shows the final phases of rallies have provided some of the biggest gains.
“Markets have been running away,” Robert Royle, who helps oversee $21 billion as manager of the North American Trust at Smith & Williamson Investment Management LLP in London, said by telephone on Aug. 20. “Everyone is hoping for a second-half recovery in fundamentals,” he said. “I am just not sure what will drive the recovery.”
The S&P 500 advanced 0.5 percent to 1,663.5 last week as global manufacturing and the American labor market showed signs the economy is improving. The index is up 17 percent this year, the largest advance over a comparable period since 1997, and climbed to an all-time high of 1,709.67 on Aug. 2.
The S&P 500 has risen 146 percent since bottoming in 2009. The 53-month gain has surpassed the average length of bull markets since 1946 by about four months, data compiled by Bloomberg show. The index gained 0.3 percent at 11:04 a.m. in New York today.
Combined profit at S&P 500 companies surged 37 percent in 2010, 19 percent in 2011 and slowed to 2.3 percent last year, Bloomberg data show. Earnings increased 3.6 percent and 3.7 percent in the first and second quarters. Analysts have cut projections for 2013 profit by 0.7 percent this year to $110.22, a 9 percent increase from last year, based on more than 11,000 estimates compiled by Bloomberg.
The last time gains in stocks outpaced profit expansion by this much was in 1999, when equity valuations surged 19 percent in a year to 30 times reported profit, according to data compiled by Bloomberg. That bull market ended the following year, with the S&P 500 tumbling 49 percent from March 2000 through October 2002 as the dot-com bubble burst.
In 1987, prices rose so fast, valuations increased 43 percent through August, about twice the pace of the year before. That month marked the peak in a five-year rally, followed by a 34 percent loss through December 1987.
U.S. equities have been whipsawed since May, when Fed Chairman Ben S. Bernanke first indicated that the central bank may start to reduce its quantitative easing bond buying this year. The S&P 500 fell 5.8 percent from a high on May 21 through June 24 and rallied 8.7 percent through Aug. 2, before declining 2.7 percent.
Corporate earnings need to accelerate to justify the surge in equities as the central bank begins to scale back its unprecedented monetary stimulus, according to Joost van Leenders of BNP Paribas Investment Partners in Amsterdam.
“There’s been a lot of hope and expectations that things will improve in the second half,” Van Leenders, who helps oversee $660 billion as a strategist at BNP Paribas, said by phone on Aug. 22. “The improvement in earnings growth has been delayed from the third quarter to the fourth quarter. Not many companies are giving forward guidance, and those that are, are giving negative outlooks.”
While U.S. stocks may be in the final leg of a bull market, that’s often the stage with the biggest gains as bears capitulate, according to Laszlo Birinyi, president of Birinyi Associates Inc. In this last phase, which Birinyi calls exuberance, equity markets have surged 39 percent on average.
Birinyi, one of the first money managers to advise clients to buy in 2009, wrote in a Aug. 7 report that the rally in U.S. equities was poised to slow after the 17 percent surge this year. He predicted that the S&P 500 may climb to a new high of 1,740 by December, 4.6 percent above the current level. The S&P 500 exceeded Birinyi’s forecast of 1,600 in May.
Even as the S&P 500 valuation expanded this year, it remains below the level at which previous rallies peaked. The average multiple during bull runs since 1957 has been 17.4 times reported profits, about 10 percent higher than today’s ratio, data compiled by Bloomberg show. Advances ended at 20.2 times earnings on average, 26 percent higher than the present level.
“It’s more important how high the valuation is than how long it took to get there,” Russ Koesterich, the chief investment strategist at New York-based BlackRock Inc., said by phone on Aug. 22. BlackRock is the world’s largest money manager, with $3.8 trillion in assets. “Valuations today are below where they were in 2007 and much, much below their levels in 2000.”
The S&P 500 traded at 17.5 times earnings when the index hit a high of 1,565.15 on Oct. 9, 2007, Bloomberg data show. The valuation reached 31 times income in March 2000 as it peaked at 1,527.46.
Caterpillar’s valuation has climbed 28 percent in the past year as the largest manufacturer of mining and construction machinery posted three quarters of earnings declines. Analysts predict a profit drop of 27 percent in 2013. Last month, the Peoria, Illinois-based company cut its earnings forecast as mining-equipment sales declined on slower commodity demand from emerging markets.
Analysts see earnings increasing 6 percent at Danaher this year, Bloomberg data show. That’s the slowest pace since the maker of dental and laboratory equipment posted a 17 percent profit plunge in 2009. In July, the Washington-based company lowered its earnings forecast for 2013 to no more than $3.42 a share after predicting in April adjusted profit will be as much as $3.47.
Consumer-discretionary companies posted the biggest multiple expansion out of 10 S&P 500 industries in the last 12 months, with the valuation for the group surging 39 percent, data compiled by Bloomberg show.
TripAdvisor Inc.’s price-earnings ratio surged 85 percent as profit rose 4.8 percent in 2012 and is projected to increase 11 percent in 2013, according to Bloomberg data. Stephen Kaufer, chief executive officer of the Newton, Massachusetts-based online travel-recommendation service, said on Aug. 14 he’s “not seeing a lot of positive stuff” in the third quarter as the summer has been “bumpier” and traffic is weaker than expected.
Investors have paid up for stocks in anticipation that earnings growth will rebound, and companies must now deliver for the equities rally to continue, according to Franz Wenzel, who helps oversee $759 billion as a strategist at Axa Investment Managers in Paris.
“Over the last two years we saw equity markets jump through liquidity and re-rating; this story is behind us,” Wenzel said by phone on Aug. 21. “We don’t think further multiple expansion is feasible. We need the economic underpinning.”
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