Per Thomson Reuter’s This Week in Earnings, the “forward 4-quarter” estimate for the SP 500 fell last week to $119.19 from $119.23.
The p.e ratio on the forward estimate is now 15.6(x). The PEG ratio rose a little last week to 2.58(x).
The earnings yield on the SP 500 fell to 6.41% from last week’s 6.49%. It continues to decline from its July, 2012 record high of 8.25%.
The year-over-year growth rate on the forward estimate fell to 6.05% from last week’s 6.15% and the late 2013 high of over 8%.
SP 500 valuation
If assume that 2013’s final EPS number will be around $110, full year 2013 earnings growth will likely come in around 7% – 7.5%, given the impact of the JP Morgan litigation charge taken in q3 ’13, so the SP 500 at 15.6(x) forward earnings is thought to be pretty fairly valued around 2.0(x) PEG or P.E-to-Growth ratio. 2014’s expected growth rate currently is
The SP 500 made a new high this week and broke out solidly above the 12/31/13 closing high for the SP 500 of 1,848, but we are not yet seeing the rate of change in the forward growth estimate. In fact the forward growth estimate is falling, which isn’t something we like seeing.
For Fed Model watchers, the 6.41% earnings yield versus the 2.66% 10-year Treasury yield still says that the SP 500 is a screaming buy relative to the US Treasury market, and stocks should be over-weighted relative to Treasuries. The “Fed Model Spread is currently +375 basis points (SP 500 earnings yield minus the 10-year Treasury), but the same model was at the same level in early 2008, and all throughout the summer of 2008. The Fed Model isn’t a timing tool, but a relative valuation measure, and even with qualifying the model in that fashion, you have to use it with a grain of salt. The again, 2008 was completely off the Richter scale in terms of what happened, so pretty much any valuation measure was likely found to be wanting.
If we used a “capitalized earnings model” for the Sp 500 here is what gets interesting: walking through the math, if we use $110, per share for the SP 500 as full-year 2013 EPS, and discount those earnings at the Barclay’s Aggregate current yield of 2.28%, the “fair value” for the SP 500 becomes 4,800 ($110 / .0228) for the SP 500. Even if we use a nominal 5% “average” corporate investment-grade bond yield for the discounting of earnings, the $110 per share divided by .05 = 2,200 or another 20% gain from current levels. To be fair, this is the same analysis Brian Wesbury, the economist at First Trust has used for years, and to be frank, I learned it from him. Brian’s point which I think every reader can quickly see, is that higher interest might not be the negative that many perceive them to be, just like the rapid collapse in interest rates was not the immediate positive in 2008 and 2009.
Conclusion: the technical breakout in the SP 500 this week isn’t too be ignored. Id like to see that forward earnings growth rate start to drift towards 8% and then 10% in 2014, so that the SP 500 isn’t driven entirely by p.e expansion. Healthcare, which is roughly 13% of the SP 500 by market cap, has the best revenue growth of any sector for q4 ’13 at +7.8% and is leading again in 2014. I think a lot of this growth is being driven by biotech’s, which is seeing sector revenue growth of 21%. We prefer Pfizer and Merck for clients along with Amgen, Johnson & Johnson and Intuitive Surgical. We had good numbers for clients in 2013, without biotech (with the exception of Amgen, which has really morphed into a large-cap pharma company) and I absolutely wouldn’t buy biotech without a decent correction first. (Long all 5 mentioned)
Commodity sectors are doing well this year, too. Basic Materials, gold, silver, Energy have markedly improved after being at the bottom of the asset class performers the last few years.
Like the good lawyer once answered, when asked about whether the SP 500 is overvalued or undervalued, “I can argue it either way”.
Q1 ’14 SP 500 earnings growth is currently expected at +3%. This will be the lowest rate of earnings growth since q3 ’12.
We’ll be back with more sector analysis later.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio Manager