What is the underlying earnings power of S&P 500 companies? Clearly, the market has ratcheted up its expectations for that earnings power in the past 3 months. The market’s 15% rally speaks to that. While earnings results have been flat, the expectation machine has become much more constructive.
Here is a chart of the earnings of S&P 500 companies over the past 5 years, along with consensus estimates for the next 2 years compressed on the right side of the graph (to the right of the green line):
In late 2007, earnings for the SPX index peaked around $90 per share. Today’s earnings per share figure is in the high-90s, where it has been for much of 2012. The bull / bear debate on a macro basis rests on two points:
1) What is the correct multiple for the SPX index? Bulls argue that the current market is more appropriately priced than the SPX index at the highs of 2000 or at the highs of 2007. The P/E ratio is lower than in both of those peak years, as earnings are higher, and the SPX index is still 7-8% from new highs. The bears argue that the balance sheet of the nation (and the world) is in much worse shape, and policy action fights against the zero bound, hindering future growth potential relative to the past. As a result, a lower multiple is justified.
2) What is the future path of earnings for SPX index companies? I view the answer to this question as much more important for the bull / bear debate than question 1. Earnings have had their longest stagnant run over the past 6 months since the start of the bull market in 2009. Bears like Jim Rogers argue that the natural timing of the business cycle has turned, and earnings reports like FDX confirm that story. Bulls like most CNBC guests argue that unprecedented stimulus will re-invigorate demand in the next year, and AAPL’s price action in the past couple months, despite a weak Q2 earnings report, speak to that view.
Regardless, I will have a keen eye on earnings reports over the next 6 months. The uncertainty in their future trend is greater than it has been in many years.
Markets overnight:
- More central bank stimulus, this time from the Bank of Japan (about $125 billion more in bond purchases), dominated overnight headlines. Asia was green, with the Nikkei and the Hang Seng both up more than 1%.
- Europe sold off after the open for the 3rd straight day, going from +1% to close to flat now. SPX futures were up 0.4%, and are now up 0.1%
- The dollar rallied after the European open as risk-off took hold, with the Euro near 1.30. The Aussie dollar is the first major cross to give up its QE gains after the central bank expressed concerns about Chinese growth