Monthly Market Monitor - March 2010

Earning and Valuation
After starting off the year in negative territory, most major equity indexes rebounded in February. One catalyst for the recovery was a strong earnings season. With about 85% of companies in the S&P 500 having reported earnings as of 02/25/10, the results so far have generally been positive. As outlined in the table below, slightly more than 73% of the companies that have reported Q4 earnings managed to post positive surprises (meaning that their reported earnings per share came in ahead of analysts’ forecasts). At the same time, only 17% failed to meet expectations. This suggests that analysts have still not priced the economic recovery into their EPS estimates. Nearly every sector in the S&P 500 came in ahead of expectations with the exception of telecommunication services. Another encouraging sign is that companies are beginning to report improvements in the absolute level of earnings growth. For example, earnings growth in both consumer discretionary and information technology was above 20%. And only three industries reported declines. Of course, some of this growth stems from the fact that year over year comparisons are made easier by the low level of reported EPS from Q4 of ’09. Some analysts are now pointing out that positive surprises are stemming not only from cost cutting measures but from actual revenue growth as well.

Source: Ned David Research 02/25/09

The other half of the P/E ratio is of course “price.” No matter how well earnings are recovering, investors need to be aware of what they are paying for such earnings. According to the most recent estimates from Standard & Poor’s, analysts are forecasting operating earnings of $69.06 for the S&P 500 as a whole in 2011. At a closing price of 1,104.49 (on 02/26/10), this equates to a price-to-earnings multiple of about 16X. This is nearly identical to the 40-year average of 16.5, suggesting that the S&P 500 is neither over nor undervalued. Some analysts caution, however, that the underlying weakness of the economy warrants a cheaper multiple. Others counter that valuations are reasonable given that we are in the midst of an economic recovery.

While the economy continues to improve and many indicators point to an ongoing recovery, some strategists point out that a few pockets of concern remain. The first is with respect to consumer spending. Unemployment rates remain high and wage growth is stagnant. Given this combination, it is difficult to argue for a robust pick up in consumer spending in the near term. And since consumer spending accounts for about 70% of GDP, it will be hard to generate above average GDP growth without a sustained recovery in consumer spending.

Another potential area of concern is the rising federal budget deficit coupled with strained resources at the state level. Both of these issues hint at higher interest rates and/or higher taxes at some point in the future, which would lead to slower growth. While certainly a longer term problem, these are issues worth paying close attention to going forward.

1. Wall Street Journal, 03/01/10

The views are those of Cameron Lavey, Senior Investment Analyst, Research Department, Cetera Financial Group, and should not be construed as investment advice.

All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information.

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