Tag: S&P 500

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U.S. Corporate Profits

S&P 500 earnings declined in 2022 by 18.0% and subsequently increased by 7.8% in 2023.  Standard and Poor’s currently estimates that 2024 earnings for the S&P 500 index will be $216.61, representing 10.6% growth for the calendar year.  At the current price level of 5,283.4, the S&P 500 Index sells at 24.4x 2024 estimated earnings.

There has been much commentary about the “Magnificent 7” (Microsoft, Amazon, Meta Platforms, Apple, Alphabet, Nvidia, and Tesla).  The Magnificent 7 sell for roughly twice the P/E ratios than most other US stocks.  While five of the stocks have high growth rates, Apple and Tesla have negative revenue growth when we compare the most recent quarter to a year ago.

Richard Bernstein Advisors (RBA) has this to say in their commentary about the divergence between the large cap tech stocks and the rest of the stock market.

Our work in the early-1990s demonstrated that stock market leadership narrows when profits cycles decelerate because fewer and fewer companies can accelerate or even maintain growth in an increasingly adverse environment.  Markets effectively reflect Darwinistic survival of the fittest as earnings growth becomes increasingly scarce.

However, the opposite occurs when profits cycles accelerate.  Markets tend to broaden as the cycle accelerates because an increasing number of companies are growing, and investors become comparison shoppers for growth.

RBA notes that a high percentage, 32% of S&P 500 companies, have more than 25% earnings growth based on the last 4 quarters.  In their opinion, “profits are accelerating and credit conditions remain healthy.”  They expect the performance of the stock market to broaden and the Magnificent 7 to “substantially underperform.”

The Atlanta Fed’s GDPNow forecast for the second quarter has declined during the last month from 4.1% to 1.8%.  A slowdown in economic growth will make it difficult to sustain earnings growth for many companies.

One of the reasons why small capitalization companies have been underperforming the S&P 500 since 2021 is that they typically have a higher debt load with a greater proportion of variable rate debt.  Interest rates have been rising since June 2020, so small companies with more interest-sensitive debt have suffered.  According to Pacer Financial, an ETF provider, the S&P Small Cap 600 has net debt/EBITDA (earnings before income tax, depreciation, and amortization) of 3.5 compared to 1.4 for the S&P 500.

Pacer’s US Small Cap Cash Cows ETF (CALF), which is included in many portfolios, has a lower ratio of net debt/EBITDA at 1.26, but sells at a more attractive valuation than either index.  CALF has a price/free cash flow ratio of 8 and a price/earnings ratio of 11.

While there are reasons to be concerned about the economic future of the country (see my May 3 blog, “Prepare for All Eventualities), some stocks offer better fundamentals and more attractive valuations than other stocks.  Also, we deal in a world of probabilities rather than certainties, and an allocation to common stocks makes sense as a hedge against inflation.

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA

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What’s Next?

US real (after inflation) GDP declined by 1.6% in the first quarter of 2022.  According to the Atlanta Federal Reserve Bank’s GDPNow model as of July 1, second quarter real GDP is forecast to decline a further 2.1%.  The Blue Chip Economic Indicators consensus forecast of economists for real GDP was a full 5% higher at the end of May than the latest forecast of the Atlanta Fed’s model.  There are likely to be substantial reassessments by economists and securities analysts during the next few months.

The current P/E ratio of the S&P 500 Index is at 19.3 based upon the last 12 months of reported earnings.  The P/E ratio of equities held in client portfolios is lower than the S&P 500 due to my value orientation.  The P/E ratios of some stocks are substantially lower than the rest of the stock market.  For example, US Steel (X) sells at 1.0X trailing 12 months earnings, or 1.5X forecast earnings.

Year-to-date, the total return of the S&P 500 is -19.1%.  Since the Fed is expected to raise interest rates further and there is a high probability that we are in a recession that will impact corporate profits, the S&P 500 Index is likely to decline further during coming months.

The potential catalyst(s) for a turnaround in the economy are difficult to identify.  Here are some current economic indicators:

    • The consumer price index (CPI) is currently 8.6% higher than a year ago, and it is expected to remain at an elevated level for the near future.
    • The University of Michigan’s consumer sentiment index hit a record low, as the high inflation rate is hurting household finances.
    • Real (after inflation) wage growth on a year-over-year basis is lower at -3.9%.
    • The market capitalization of US equity markets has declined by $13.6 trillion since its peak at the beginning of this year.
    • The interest rate on a 30-year fixed rate mortgage is now at 5.81%.
    • Corporate profit margins are at record high levels but are likely to be under pressure from higher wage and material costs and a recessionary environment.

Meanwhile in Europe, the antagonism between NATO countries and Russia may soon get worse.  Russia has already reduced Nord Stream 1 gas flows by 40% while citing technical issues.  Gazprom then announced that they have scheduled an “annual maintenance” for a period of ten days from July 11 to July 21, that will shut down gas deliveries.  This should serve as a painful reminder to the NATO/European Union countries that they rely on Russian energy exports.  Germany and Italy together account for almost half of the European Union’s gas imports from Russia.  France, Hungary, the Czech Republic, Poland, and Austria are also large natural gas importers.

Some European companies have already hit their breaking point.  Germany’s largest gas importer and power utility, Uniper, is now seeking a 9 billion euro bailout package from the German government.  Uniper’s share price has declined by about 75% since the beginning of the year.

For now, the European energy supply problems have benefited American companies that are able to liquify natural gas (LNG) and export it to Europe at higher prices.  However, the LNG infrastructure has limited capacity.  If Russia takes the next step and eliminates energy supplies to Europe, an economic depression for the European economy is inevitable and will have consequences for the American economy and financial system.

What’s the good news?  The market declines of 2008-2009 and 2020 created some great buying opportunities.  We may see a similar opportunity before the year is over.  In the meantime, we have a low allocation to equities, debt with high credit ratings and shorter maturities.  We have a large allocation to precious metals, which did well until mid-April.  I expect more investors to recognize the importance of including precious metals in their investment portfolios in the future.

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA

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Doubleline Round Table: Market Outlook

On January 10, DoubleLine Capital had a panel of some highly regarded investment strategists discuss their 2022 market outlooks.  56 minutes.  https://www.youtube.com/watch?v=sgvIEPd7M8E

On the panel were:

  • Jeffrey Sherman, Deputy Chief Investment Officer of DoubleLine Capital;
  • James Bianco, President and Macro Strategist at Bianco Research;
  • Danielle DiMartino Booth, CEO and Chief Strategist of Quill Intelligence;
  • Jeffrey Gundlach, Founder and CEO of DoubleLine Capital;
  • Ed Hyman, Chairman and Head of Research of Evercore ISI;
  • David Rosenberg, President, Chief Economist and Strategist of Rosenberg Research & Associates.

During the discussion, there are some references to S&P 500 earnings, Price/Earnings ratios, and 10 year US Treasury rates.  This website has graphs of the historical data.  See the tabs at the top.  https://www.multpl.com/

If you have any questions or comments, please contact me.

Robert G. Kahl
CFA, CPA, MBA

 

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Schwab 2021 US Market Outlook

This month, I will refer investors to the Schwab 2021 US Market Outlook by Charlos Gary as I believe it offers a good summary of the economy and financial markets.  Some key takeaways:

  • Gross domestic product (GDP) has not fully recovered from its contraction since the first calendar quarter.
  • Consensus economic forecasts for GDP growth in 2021 are in the 3.1-3.4% range.
  • Permanent job losses have increased steadily during 2020.
  • Unemployment has declined from a peak of 14% in the spring to under 7% now.
  • The most frequent questions on Schwab webcasts are related to the federal budget deficit, debt, and inflation.
  • The Big 5 stocks (Alphabet, Amazon, Apple, Facebook, and Microsoft) account for 25% of the capitalization of the S&P 500 and their year-to-date performance exceeds the other 495 stocks of the S&P 500 by over 40%.
  • The forward price/earnings ratio (based on a forecast for the next 12 months) of the S&P 500 is currently at 26, matching the peak level of the “tech bubble” of 2000.  However, the P/E of the Big 5 stocks now is nearly half the level of the Big 5 stocks of 2000.
  • Sentiment indicators indicate extreme optimism, which is bearish for the market.  Net foreign purchases of US stocks are at record levels.
  • Their concluding line: “Investors should remain disciplined, diversified and opportunistic with regard to rebalancing.”  I agree.

If you would like to read the full article, click on the following link:  2021 U.S. Market Outlook: Better Days? | Schwab Funds

The Recent Merger

As most of you know by now, Charles Schwab recently completed their acquisition of TD Ameritrade, which I have used as custodian (including the predecessor organizations) for client accounts for more than twenty years.  For now, TD Ameritrade operations will continue as though it is a separate entity, but eventually their operations will be merged.  Charles Schwab has an excellent reputation and I expect a good working relationship with them in the future.

If you have any questions, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA