Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Gold, Silver & HUI Stocks Big Pictures - 28th Sep 20
It’s Time to Dump Argentina’s Peso - 28th Sep 20
Gold Stocks Seasonal Plunge - 28th Sep 20
Why Did Precious Metals Get Clobbered Last Week? - 28th Sep 20
Is The Stock Market Dow Transportation Index Setting up a Topping Pattern? - 28th Sep 20
Gold Price Setting Up Just Like Before COVID-19 Breakdown – Get Ready! - 27th Sep 20
UK Coronavirus 2nd Wave SuperMarkets Panic Buying 2.0 Toilet Paper , Hand Sanitisers, Wipes... - 27th Sep 20
Gold, Dollar and Rates: A Correlated Story - 27th Sep 20
WARNING RTX 3080 AIB FLAWED Card's, Cheap Capacitor Arrays Prone to Failing Under Load! - 27th Sep 20
Boris Johnson Hits Coronavirus Panic Button Again, UK Accelerting Covid-19 Second Wave - 25th Sep 20
Precious Metals Trading Range Doing It’s Job to Confound Bulls and Bears Alike - 25th Sep 20
Gold and Silver Are Still Locked and Loaded… Don't be Out of Ammo - 25th Sep 20
Throwing the golden baby out with the covid bath water - Gold Wins - 25th Sep 20
A Look at the Perilous Psychology of Financial Market Bubbles - 25th Sep 20
Corona Strikes Back In Europe. Will It Boost Gold? - 25th Sep 20
How to Boost the Value of Your Home - 25th Sep 20
Key Time For Stock Markets: Bears Step Up or V-Shaped Bounce - 24th Sep 20
Five ways to recover the day after a good workout - 24th Sep 20
Global Stock Markets Break Hard To The Downside – Watch Support Levels - 23rd Sep 20
Beware of These Faulty “Inflation Protected” Investments - 23rd Sep 20
What’s Behind Dollar USDX Breakout? - 23rd Sep 20
Still More Room To Stock Market Downside In The Coming Weeks - 23rd Sep 20
Platinum And Palladium Set To Surge As Gold Breaks Higher - 23rd Sep 20
Key Gold Ratios to Other Markets - 23rd Sep 20
Watch Before Upgrading / Buying RTX 3000, RDNA2 - CPU vs GPU Bottlenecks - 23rd Sep 20
Online Elliott Wave Markets Trading Course Worth $129 for FREE! - 22nd Sep 20
Gold Price Overboughtness Risk - 22nd Sep 20
Central Banking Cartel Promises ZIRP Until at Least 2023 - 22nd Sep 20
Stock Market Correction Approaching Initial Objective - 22nd Sep 20
Silver Bulls Will Be Handsomely Rewarded - 21st Sep 20
Fed Will Not Hike Rates For Years. Gold Should Like It - 21st Sep 20
US Financial Market Forecasts and Elliott Wave Analysis Resources - 21st Sep 20
How to Avoid Currency Exchange Risk during COVID - 21st Sep 20
Crude Oil – A Slight Move Higher Has Not Reversed The Bearish Trend - 20th Sep 20
Do This Instead Of Trying To Find The “Next Amazon” - 20th Sep 20
5 Significant Benefits of the MT4 Trading Platform for Forex Traders - 20th Sep 20
A Warning of Economic Collapse - 20th Sep 20
The Connection Between Stocks and the Economy is not What Most Investors Think - 19th Sep 20
A Virus So Deadly, The Government Has to Test You to See If You Have It - 19th Sep 20
Will Lagarde and Mnuchin Push Gold Higher? - 19th Sep 20
RTX 3080 Mania, Ebay Scalpers Crazy Prices £62,000 Trollers Insane Bids for a £649 GPU! - 19th Sep 20
A Greater Economic Depression For The 21st Century - 19th Sep 20
The United Floor in Stocks - 19th Sep 20
Mobile Gaming Market Trends And The Expected Future Developments - 19th Sep 20
The S&P 500 appears ready to correct, and that is a good thing - 18th Sep 20
It’s Go Time for Gold Price! Next Stop $2,250 - 18th Sep 20
Forget AMD RDNA2 and Buy Nvidia RTX 3080 FE GPU's NOW Before Price - 18th Sep 20
Best Back to School / University Black Face Masks Quick and Easy from Amazon - 18th Sep 20
3 Types of Loans to Buy an Existing Business - 18th Sep 20
How to tell Budgie Gender, Male or Female Sex for Young and Mature Parakeets - 18th Sep 20
Fasten Your Seatbelts Stock Market Make Or Break – Big Trends Ahead - 17th Sep 20
Peak Financialism And Post-Capitalist Economics - 17th Sep 20
Challenges of Working from Home - 17th Sep 20
Sheffield Heading for Coronavirus Lockdown as Covid Deaths Pass 432 - 17th Sep 20
What Does this Valuable Gold Miners Indicator Say Now? - 16th Sep 20
President Trump and Crimes Against Humanity - 16th Sep 20
Slow Economic Recovery from CoronaVirus Unlikely to Impede Strong Demand for Metals - 16th Sep 20
Why the Knives Are Out for Trump’s Fed Critic Judy Shelton - 16th Sep 20
Operation Moonshot: Get Ready for Millions of New COVAIDS Positives in the UK! - 16th Sep 20
Stock Market Approaching Correction Objective - 15th Sep 20
Look at This Big Reminder of Dot.com Stock Market Mania - 15th Sep 20
Three Key Principles for Successful Disruption Investors - 15th Sep 20
Billionaire Hedge Fund Manager Warns of 10% Inflation - 15th Sep 20
Gold Price Reaches $2,000 Amid Dollar Depreciation - 15th Sep 20
GLD, IAU Big Gold ETF Buying MIA - 14th Sep 20
Why Bill Gates Is Betting Millions on Synthetic Biology - 14th Sep 20
Stock Market SPY Expectations For The Rest Of September - 14th Sep 20
Gold Price Gann Angle Update - 14th Sep 20
Stock Market Recovery from the Sharp Correction Goes On - 14th Sep 20
Is this the End of Capitalism? - 13th Sep 20
The Silver Big Prize - 13th Sep 20
U.S. Shares Plunged. Is Gold Next? - 13th Sep 20
Why Are 7,500 Oil Barrels Floating on this London Lake? - 13th Sep 20
Sheffield 432 Covid-19 Deaths, Last City Centre Shop Before Next Lockdown - 13th Sep 20
Biden or Trump Will Keep The Money Spigots Open - 13th Sep 20
Gold And Silver Up, Down, Sideways, Up - 13th Sep 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

US Corporate Earnings Peaking - Shift into Defensive Growth Stocks

Stock-Markets / Corporate Earnings May 17, 2011 - 12:45 PM GMT

By: Rory_Gillen

Stock-Markets

Best Financial Markets Analysis ArticleThe recovery in global stock markets, which started in mid March 2009, is just over two years old. Many commentators feel that the recovery is illusory, based on cheap money from central banks and reckless fiscal spending by governments desperate to stave off recession and rising unemployment. Others see an improving global economy with the emerging markets as the new locomotive of world growth underpinned by rising populations, the urbanisation of China and India in particular and the consequent growth in emerging economy middle class incomes, which has brought some two billion consumers into the global economy.


There is no doubting that the global economy is unbalanced - debt is too high in many developed economies and consistent trade imbalances remain a destabilising force. But that is the macro view and very hard for anyone to draw a conclusion from.

If we focus on the world’s largest and most influential equity market, the US S&P 500, there are only a couple of key variables that determine how cheap or expensive the market is relative to history. Those variables include;

  • The trend of US corporate earnings
  • The levels of corporate earnings versus overall economic output in the US
  • and competition from interest rates (or bond yields)

US Corporate Earnings

Chart A highlights the long term trend in earnings in the 500 companies making up the S&P 500 Index. This is a diverse index made up of companies across a broad range of sectors aimed at representing the US economy. The chart makes a few key points. The first is that analysts at Standard & Poors expect earnings of $96 for the S&P 500 Index in 2011, a new peak in earnings. In addition, this has been one of the fastest recoveries in earnings following recession in history.

At the current S&P 500 index level of 1,341 (at the time of writing), the $96 of earnings means that investors are paying 14 times expected 2011 earnings, which is at or around the long term average investors have paid over the long term (see Chart B). No worries so far!

Corporate Earnings versus Economic Output

But we must also remember that the level of corporate earnings is a function of economic output and, over time, there tends to be a fairly stable relationship between the how much of the economic pie goes to companies and how much to other parts of society like labour (or wages).

Chart C shows that US corporate pre tax earnings have averaged circa 10% of GDP through all the business and economic cycles since 1960, some 50 years of data. Currently, US earnings are at 12.2% of GDP which is some 20% ahead of the long term norm. This is reason enough to query whether the market is being overly optimistic in expecting earnings for the S&P 500 companies to rise further this year from $87 to $96. History suggests the opposite if more likely – that US earnings are more likely to revert to the mean and back towards the long term average of 10% of GDP. US corporate profits are a function of economic output and cannot outgrow the economy for long.

Chart C, therefore, paints an altogether more sobering picture - one where current earnings in the US economy are already back to near a peak when compared to economic output. Hence, while investors appear to be paying fair value of 14 times US earnings they are paying that for peak earnings. On that basis, we might conclude that the valuation of the US equity market is some 20% above long term norm and, therefore, overvalued in the short term.

Assets Can’t be Valued in a Vacuum

But the tricky part comes next. The valuation of any asset class has to be judged against the alternatives. Accountants have no problem with numbers so I will use more here. In 1999, the US equity market was trading on circa 25 times prospective earnings. That can be equally expressed as an earnings yield of 4.0% i.e. the S&P 500 earnings, in aggregate, represented 4.0% on the price being paid. The trouble at that time was that the risk-free US government 10-year bond was offering a yield of 6.3%. In other words, the value lay in US bonds. The subsequent ten years have delivered miserable return to investors in the US stock market, not due to bad luck or recessions but due to the simple fact that equities were grossly overvalued relative to history and the simple alternative of bonds at that time.

Roll forward to 2011 and the issue is not anywhere near as clear cut. If we accept that the 500 companies making up the S&P 500 will earn $96 dollars in 2011 and that the market remains at the current level of 1,341, then the US equity market currently offers an earnings yield of 7.2%. In comparison, the US 10-year government bond yields 3.3% (at the time of writing).

In 1999, the value in US bonds over US equities was clear. Today, it appears that US equities offer a higher earnings yield than US bonds. But the certainty one attaches to peak earnings must be low, and a betting man would assume that US earnings cannot hold their current levels.

This probably leaves us in no-man’s land! US government 10-year bonds look unattractive and US equities, while potentially cheap versus bonds, are possibly 20% overvalued when looked at in isolation relative to the long term norm.

But pockets of value exist and value investing is all about understanding that the return you get is heavily linked to the value you buy (or price you pay) at the outset.

Chart D highlights the radically different earnings profile of the US global consumer franchise stocks. This chart averages the earnings of eight such companies since 1989 – Coca Cola, Kraft, Johnson & Johnson, Kellogg, McDonalds, Wal-Mart, Proctor & Gamble & Colgate – and compares their earnings to the S&P 500. Not only have these great companies grown their earnings at double the pace but they have done so with little or no interruption i.e. they possess the elusive ‘Reliability of Earnings’ factor.



And reliability of earnings combined with an ability to grow should be highly prised by investors. But Chart E highlights that this collection of stocks is available on an average price-to-earnings rating of 15, as low a rating in quite some time.

And finally, a price-to-earnings ratio of 16.4 equates to an earnings yield of 6.1% which is almost double the current 10-year bond yield of 3.19% (Chart F). And bonds offer no growth. For these reasons, I’d own these stocks before I’d buy the S&P 500 Index or American stocks in general or US government bonds.

Rory Gillen

Founder

www.investRcentre.com

Rory Gillen is a qualified Chartered Accountant, a former equity analyst, stockbroker and fund manager who has spent over twenty years working in the financial services industry. He founded The InvestR Centre in 2005 as a stock market training company. www.investrcentre.com

© 2011 Copyright Rory Gillen - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules