What is driving these new market highs?

 

November 2013

Disclaimer: The information and opinion expressed here are solely the opinion of Tellsons Investors LLP and should not be construed as advice nor form the basis of any investment decision.

 

Earnings per share of the S&P 500 in the US grew less than a real 2% for the 12 months to June driven by sales growth of a mere 1.1% in real terms. The long term historical average for the EPS growth of the US market (12 month rolling) has been nearer to 7%. On the other hand, corporate profitability has been running at historically high levels, as demonstrated in the chart below.

 

corporate-profits

 

The current valuation of the S&P500 would suggest that either further cost cutting will be needed to continue these levels of profitability or sales growth is expected to make an heroic contribution to rising earnings growth. With financing rates, wages, and employment as low as they are, we don’t see much prospect for the former; and with the grinding slow recovery we have become familiar with in the main economies – and developing economies fighting their own demons – indications of that kind of sales growth are elusive. The high Price to Earnings (PE) valuation we currently see on the S&P500 is comparable to only three other periods in the past 130 years, highlighted in grey below:

 

cyclically-adjusted-PE
……in the months around the Wall Street Crash of 1929, the Tech & Telco Bubble of 2000, and the Credit Crisis of 2008. This time could indeed be different, as the last few years of pent-up investment and consumption will at some point drive the next business cycle, but it just seems to us like too much valuation, with so much policy dependency, too early in this cycle.

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