Cor­po­rate prof­its are up, and in­vestors ex­hale a bit

Daily Local News (West Chester, PA) - - BUSINESS - By Stan Choe AP Busi­ness Writer

When cor­po­rate prof­its are on the up­swing, as they seem to be for the first time in more than a year, in­vestors usu­ally get ex­cited. Th­ese are not usual times.

The re­ac­tion has been more “phew” than “hooray” for many fund man­agers this earn­ings re­port­ing sea­son, even with the Stan­dard & Poor’s 500 in­dex on pace to re­port its first quar­ter of profit growth since the spring of 2015. The sub­dued re­ac­tion is the re­sult of how ex­pen­sive stocks have be­come. Earn­ings need to rise even faster than they are now to jus­tify the mar­ket’s lofty prices.

The U.S. stock mar­ket “is cer­tainly priced for per­fec­tion,” says Maura Mur­phy, co-port­fo­lio man­ager of the Loomis Sayles Multi-As­set In­come fund. “If we don’t see earn­ings pick up, that’s a real risk be­cause val­u­a­tions are stretched.”

Roughly half of the com­pa­nies in the Stan­dard & Poor’s 500 in­dex have al­ready re­ported their re­sults for the July-through-Septem­ber quar­ter, and gains for banks and health care com­pa­nies look to be off­set­ting con­tin­ued drops for oil pro­duc­ers. An­a­lysts ex­pect to see earn­ings growth of 1.1 per­cent for the S&P 500 in the third quar­ter from a year ear­lier, ac­cord­ing to Fac­tSet. While that’s cer­tainly low, it’s at least mov­ing in the right di­rec­tion.

In­vestors are bank­ing on the gains get­ting even big­ger. That’s why in­vestors con­tin­ued to pay high prices for stocks over the last year, even as cor­po­rate prof­its dripped lower. Mur­phy says she ex­pects growth to get back to the “high sin­gle-digit” per­cent­age level that in­vestors ap­pear to be ex­pect­ing, as in­ter­est rates re­main low and the econ­omy con­tin­ues its mod­est pace for­ward.

Wall Street an­a­lysts are even more op­ti­mistic, and they are fore­cast­ing earn­ings growth of nearly 13 per­cent in 2017 for the S&P 500, ac­cord­ing to Fac­tSet. They fore­see par­tic­u­larly big gains for en­ergy com­pa­nies on the as­sump­tion that the price of oil con­tin­ues its re­cov­ery fol­low­ing its 70 per­cent plunge over 19 months from the sum­mer of 2014 through early this year.

Oth­ers aren’t so sure. Stephen Auth, chief in­vest­ment of­fi­cer for eq­ui­ties at Fed­er­ated In­vestors, says he is feel­ing cau­tious about the mar­ket in the near term, even though he’s op­ti­mistic about the long term, be­cause growth in both cor­po­rate earn­ings and the econ­omy has been slug­gish.

He sees low in­ter­est rates hem­ming in prof­its for fi­nan­cial com­pa­nies, and he doesn’t see the price of oil mak­ing a big leap, a re­quire­ment for the en­ergy sec­tor to re­bound. That’s why he wouldn’t be sur­prised to see the stock mar­ket stum­ble in the short term, be­fore con­tin­u­ing to rise.

Strate­gists at Gold­man Sachs re­cently ratch­eted back their fore­casts for S&P 500 earn­ings growth in 2016 and 2017. They ex­pect the S&P 500 to end this year at 2,100, nearly 2 per­cent lower than Wed­nes­day’s clos­ing level. The strate­gists are call­ing for the in­dex to rise nearly 5 per­cent in 2017 to 2,200.

Fund man­agers want to see big­ger earn­ings growth be­cause stock prices have his­tor­i­cally tracked cor­po­rate earn­ings trends. That’s why the price-earn­ings ra­tio is a bedrock method used by many in­vestors to mea­sure whether a stock, or the mar­ket, is too ex­pen­sive.

To see how pricey stocks have be­come, con­sider Exxon Mo­bil. Its share price ear­lier this month was 35 times larger than its earn­ings per share from the prior 12 months. That’s much higher than its av­er­age price-earn­ings ra­tio of 12.8 over the last decade. The only way for Exxon Mo­bil’s price-earn­ings ra­tio to get back to its his­tor­i­cal av­er­age is ei­ther for its stock price to drop or for its earn­ings to get much big­ger.

Exxon Mo­bil may be an ex­treme ex­am­ple be­cause it’s part of an en­ergy sec­tor that’s strug­gling with the plum­met in oil prices, but the over­all S&P 500 is also trad­ing at a sig­nif­i­cantly higher price-earn­ings ra­tio than its av­er­age over the last decade, 18 ver­sus 14.8, ac­cord­ing to Fac­tSet.

“Most peo­ple that I talk to feel that val­u­a­tions are stretched,” Fed­er­ated’s Auth says.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.