Longest S&P 500 Valuation Slump Since Nixon Discounts Profit
Valuations for U.S. equities have been stuck below the five-decade average for the longest period since Richard Nixon's presidency, a sign investors don't trust earnings even after a three-year bull market.
Analysts estimate profits in the Standard & Poor's 500 Index will reach a record $104.78 this year after increasing 125 percent since the end of 2009, the fastest expansion in a quarter century, according to data compiled by Bloomberg.
American companies are boosting income so much that even after stocks doubled, the S&P 500 hasn't traded above its 16.4 mean ratio for 446 days, the longest stretch since the 13 years beginning in 1973.
Battered by the 14 percent decline in the S&P 500 since 2000, the worst financial crisis since the Great Depression and the so-called flash crash 21 months ago, investors are staying away from stocks, even after record profits, 10 quarters of U.S. economic growth and promises by the Federal Reserve to keep interest rates near zero through 2014. Of the $37 trillion erased from global equities in the credit crisis, $24 trillion has been restored.
"After two significant bear markets, the flash crash and the lost decade, many have simply said, ‘No mas,'" Howard Ward, who helps oversee $35 billion at Gamco Investors Inc. in Rye, New York, said in an e-mail on Jan. 24. "Of course, bull markets have a history of climbing a wall of worry. And it is happening again."
The Fed's pledge to keep interest rates low through 2014 helped send the S&P 500 up 0.07 percent to 1,316.33 last week and extended its 2012 advance to 4.7 percent, the best start to a year since 1989. At the same time, an average of 6.69 billion shares traded on U.S. exchanges in the 50 days ended Jan. 18, the fewest since at least 2008, according to data compiled by Bloomberg. Futures on the equity benchmark slipped 0.5 percent at 2:20 p.m. in Hong Kong today.
The S&P 500 trades for 13.7 times profits. It was last above the mean valuation since 1954 on May 13, 2010, less than a week after $862 billion was erased from U.S. equity values in 20 minutes, data compiled by Bloomberg show. The slump has surpassed the two longest periods of the last quarter century, in 2008 and 1988.
Profits for the 169 companies in the S&P 500 that reported earnings since Jan. 9 have risen 3.2 percent from a year earlier and beat analyst projections by 2.9 percent, the data show. Apple Inc. (AAPL) in Cupertino, California, the world's biggest technology company, Providence, Rhode Island-based defense contractor Textron Inc. (TXT) and 110 other companies posted higher- than-forecast earnings in the three months ending Dec. 31.
Companies in the S&P 500 earned $657 billion in the first nine months of 2011, including $225.2 billion between April and June, the most for any quarter in at least 12 years. That's 72 percent more than the comparable period in 2008. U.S. GDP, which grew at a slower-than-forecast 2.8 percent rate in the fourth quarter, totals about $13.4 trillion, data compiled by Bloomberg and the Commerce Department show.
"Corporate America is extremely lean, extremely efficient at this time," Peter Sorrentino, a senior fund manager who helps oversee $14.5 billion at Huntington Asset Advisors in Cincinnati, said in a Jan. 27 phone interview. "You can accumulate these stocks at attractive valuations. (SPX)"
The last two times the S&P 500 slumped below its historic average, equities rallied. The benchmark index is up 42 percent since it climbed above the five-decade mean in June 2009. It spent 14 months below the average level from August 1988 through October 1989 before quadrupling within eight years starting in October 1990, data compiled by Bloomberg show.
Multiples for the benchmark gauge rose as high as 13.82 this year. Should earnings match analyst forecasts and climb to $104.78 a share, the index would have to reach 1,718.39 to trade at the average ratio of 16.4, according to data compiled by Bloomberg. That's more than 30 percent above its last close.
The U.S. economy has expanded by an average of 2.4 percent a quarter since 2009. While that helped push the S&P 500 up 95 percent, the index's price-earnings multiple is down 43 percent. The decline is part of a decade-long retreat in U.S. equity valuations since the S&P 500 peaked at 31.2 times earnings in December 1999.
"That is not a sign of optimism, bullishness or exuberance," Hank Smith, chief investment officer at Haverford Trust Co. in Radnor, Pennsylvania, said in a telephone interview. His firm manages about $6.5 billion. "It's a sign of fear and anxiety."
Stocks vs. Bonds
Investor doubts helped send new equity sales by U.S. companies down 4 percent in 2011 as interest rates near record lows spurred companies to issue bonds instead. U.S. corporate debt sales rose 0.9 percent to $1.19 trillion, according to data compiled by Bloomberg.
Customers of U.S. stock mutual funds have pulled out more than $146 billion since May 2010 as the S&P 500's valuation shrunk by as much as 33 percent.
The longest valuation slump lasted from June 1973 through January 1986, according to data compiled by Bloomberg. The start coincided with the Watergate scandal that led to Nixon's resignation and the Arab oil embargo, marking the end of a three-year bull market as shares declined 32 percent over 16 months.
The U.S. economy contracted three of the four quarters in 1974, consumer prices climbed 12.3 percent in December and unemployment reached 9 percent in May of the following year. Gross domestic product shrank 5.1 percent from the fourth quarter of 2007 to the second quarter of 2009, according to the Commerce Department.
‘Extraordinary Long Time'
"One reason why the S&P 500's P/E has been so low is the fact that it has taken an extraordinarily long time for the GDP to reach its pre-recession level," said Komal Sri-Kumar, the Los Angeles-based chief global strategist at TCW Group Inc., which oversees about $120 billion. As in the 1970s, "we have a situation today which is also a structural change," he said in an interview on Jan. 26.
Analysts say the current slump is different from the one that started more than 38 years ago. Equities face less competition from fixed-income investments and inflation compared with the 1970s and 1980s. The yield on the 10-year Treasury note peaked at a record 15.84 percent on Sept. 30, 1981. The consumer price index surged during the oil crisis in 1973, rising from 2.7 percent in June of 1972 to 12.3 by the end of 1974. It peaked at 14.8 percent in March 1980.
Today, the 10-year yield is 1.89 percent and touched an all-time low of 1.67 percent four months ago. Consumer prices increased 3 percent from the previous year in December, according to Labor Department data.
"In the 1970s, low P/Es were accompanied by high inflation and high interest rates," Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees $40 billion, said in a Jan. 27 e-mail.
"That's obviously not the case today, where the culprit is uncertainty about the global economy and financial system." Cigna Corp. (CI)'s annual profit has risen 16.5 percent a year on average for the last two years. Shares of the fifth-largest U.S. health insurer are trading at 8.1 times reported earnings, compared with the 24.4 average since 1991.
Bloomfield, Connecticut-based Cigna has returned an average 22 percent in the 12 months after its multiple climbed back to the mean in the past, data compiled by Bloomberg show.
NextEra Energy Inc. (NEE) climbed above its 14.2 average price- earnings ratio on Dec. 23, the first time it's risen higher than the average since July 27, 2009, data compiled by Bloomberg show. While the Juno Beach, Florida-based natural gas company missed profit estimates by 6.3 percent in the third quarter, it posted a 16 percent increase in earnings when it reported fourth-quarter results on Jan. 27.
"The U.S. environment looks quite good both economically and in terms of earnings," Hayes Miller, who helps oversee about $46 billion as the Boston-based head of asset allocation in North America at Baring Asset Management Inc., said in a Jan. 25 phone interview. "It's going to be a long clean-UNNp, but we do expect markets to be up this year."
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