Monday, July 8, 2013

Analysts boosting S&P 500 target 11% reduce earnings growth

By Inyoung Hwang and Katie Brennan

The same equity analysts who lowered second-quarter profit growth predictions to almost nothing in 2013 are raising price forecasts, convinced the economy is growing fast enough to lure more investors and boost valuations.

Standard & Poor’s 500 Index (CME:SP.C) earnings rose 1.8% last quarter, down from a projection of 8.7% six months ago, according to more than 11,000 analyst estimates compiled by Bloomberg. At the same time, share-price targets for companies from GameStop Corp. (NYSE:GME) to Goldman Sachs Group Inc. (NYSE:GS) are rising at the fastest rate in two years. The U.S. equity gauge will increase 8.9% to a record 1,777.91 should the forecasts prove accurate.

Bulls say expectations for higher valuations show analysts share Federal Reserve Chairman Ben S. Bernanke’s view that the economy may gather enough momentum to expand on its own. Getting to their target would raise the index’s earnings multiple to 16.4, still about 12% lower than its 25-year average. Bears say price appreciation without profit gains shows the five-year bull market is fading and declines are inevitable. Second-quarter earnings season begins today.

“There’s a tight relationship between confidence and multiples,” Joseph Tanious, a New York-based global market strategist at JPMorgan Funds, which oversees $400 billion, said by telephone on July 3. “Confidence at these levels, while still depressed, is clearly rising,” he said. “You have an improving U.S. economy albeit at a slow pace.”

Earnings Season

Stocks advanced last week, with the S&P 500 climbing 1.6% to 1,631.89 after U.S. employers added 195,000 jobs in June and manufacturing rose more than forecast. While the index has fallen 2.2% since the May 21 record, it’s up 14% for 2013. The U.S. equity gauge climbed 0.7% to 1,643.02 as of 10:47 a.m. in New York.

Alcoa Inc. (NYSE:AA), the biggest U.S. aluminum producer, is the first Dow Jones Industrial Average company to report quarterly earnings today.

Even as the S&P 500 rallied 60% in the last three years, its price-earnings ratio remained below the long-term average of 18.6, according to data compiled by Bloomberg and S&P that begins in 1988. Valuations have held steady as profit growth matched gains in share prices since the bull market began in March 2009.

Reaching analyst price forecasts would send the S&P 500 more than 6.5% above the all-time high of 1,669.16 set May 21. Operating profits projected to reach a record $108.40 a share this year would give the index a valuation of 16.4, compared with 17.5 when the market peaked in October 2007.

Investor Sentiment

“If we were to say people were dipping their toe in the water on the economy a few years ago, now they are mid-thigh,” Joe Kinahan, chief derivatives strategist at TD Ameritrade Holding Corp., said in a July 5 phone interview from Chicago. His firm has $499.3 billion in client assets. “There is every reason to believe that the multiples should also increase.”

After three years of growth, earnings increases are slowing. Income in the S&P 500 advanced an average of 4.3% in each of the last five quarters, compared to the 28% average for 2010 and 2011, Bloomberg data show.

“You will need a strong acceleration of earnings in the third and fourth quarters for the full-year estimates to come through,” Robert Royle, a manager at the North American Trust fund of Smith & Williamson Investment Management LLP, who helps oversee $21 billion in London, said July 2. “You’ll have multiple expansion in an economy that’s not really growing fast enough.”

Slower Growth

U.S. gross domestic product will increase 1.9% this year, down from 2.2% in 2012, according to the median projection of 86 economists. The recovery since the 2009 recession is the slowest since World War II, data compiled by Bloomberg show.

While analysts say profits in the third and fourth quarters will rise 5.5% and 11.2%, respectively, their forecasts usually come down as the reporting season approaches. Since 2009, projections have declined 6.2 percentage points in the six months leading up to a quarter’s end, according to data compiled by Bloomberg.

Lower expectations helped about 73% of the companies in the benchmark measure exceed forecasts by an average of 5.1% for the first three months of the year, according to data compiled by Bloomberg. At the same time, 51% of companies reported sales that trailed estimates.

Lower Bar

Analysts are looking past profit growth this year and predicting improving investor sentiment will push stocks higher. They’ve boosted price estimates for the S&P 500 by 11% from 1,608.50 on Dec. 28, the fastest rate since July 2011, according to data compiled by Bloomberg.

U.S. equity volume, in retreat since 2009, is showing signs of picking up. Trading on all American markets has averaged 6.77 billion shares a day since the start of June, compared with 6.35 billion between January and May and 6.42 billion in 2012, according to data compiled by Bloomberg.

Shares of the three biggest public discount brokerages have rallied an average of 51% this year as individual investors buy and sell more equities. Daily average revenue-generating trades increased an average of 14% in May, compared to a year ago, according to data from Charles Schwab Corp., TD Ameritrade and E*Trade Financial Corp.

Economic Outlook

Economists are growing more optimistic after consumer spending rebounded in May, new home sales climbed more than estimated and durable goods orders beat forecasts. Growth estimates for the July-through-September period rose to 2.3% from 2.2% in May, according to data compiled by Bloomberg. U.S. gross domestic product will expand 2.7% next year, the most since 2006, estimates show.

The Fed may taper its bond purchases, or quantitative easing, if the U.S. economy improves in line with forecasts, Bernanke said June 19. The central bank has been buying $85 billion of bonds as part of an unprecedented stimulus plan after it cut interest rates near zero% December 2008.

While the size of the S&P 500 rally since 2009 is comparable to the gain in the late 1990s during the Internet bubble, valuations are about half as high. Of the 500 companies in the index, 448 stocks trade lower than their price estimates, the most since December, Bloomberg data show.

Analysts boosted price estimates for GameStop 46% this year, even as they slashed second-quarter earnings estimates 80%, according to data compiled by Bloomberg. The largest video-game specialty retailer, based in Grapevine, Texas, trades at 13.6 times earnings in the past year, or 23% less than its average over the last decade.

GameStop Price

“The share price completely looks through this year,” said Michael Pachter, a Los Angeles-based research analyst at Wedbush Securities Inc., said during a July 3 phone interview. He rates the stock the equivalent of a buy and predicts computer game releases in 2014 will fuel gains. “They’re going to have a really big start of the year next year and that should be a big positive.”

Second-quarter profit estimates for Goldman Sachs have fallen 5.4% in 2013 yet forecasts for shares of the Wall Street bank have increased 21%. Shares will rise 5.2% to $161.19 in the next year, bringing its price-earnings ratio to 11.2, or 7.1% higher than today.

Goldman Earnings

“I don’t really care what the company earns in the quarter,” Richard Bove, a bank analyst with Rafferty Capital Markets LLC who estimates the stock will reach $185, said in a July 3 phone interview. “It would appear that in each one of Goldman’s core businesses, underwriting and trading, the outlook over the next couple of years is quite strong.”

Hess Corp., the New York-based energy company, trades 10% below its decade-average multiple of 13. Hess will jump 18% to $80.21 in the next 12 months, up from an earlier forecast for $65.86, according to data compiled by Bloomberg. With second-quarter earnings estimates down 13% from six months ago, the price multiple would expand to 12.8, almost to the historic average.

“We are still going higher,” Phil Orlando, the New York- based chief equity strategist at Federated Investors, which has about $380 billion in assets under management, said by telephone on July 2. “We’re only halfway through the multiple expansion I would expect.”

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