By Ian de Lange
www.seedinvestments.co.za
Last week the US released their fourth-quarter GDP number. On the surface this looked very good — an annual rate of 5,7%. The economists who dug a bit deeper were not overly impressed with this number. The final sales number was up just 2,2% year-on-year and so the difference is accounted for in inventories or stock.
Businesses that had been running down their stock in the previous quarters did so at a slower pace than in the last quarter of 2009, and together with restocking, resulted in a net positive “growth” number.
BCA Research reckons that there are some encouraging signs that the economy is moving in the right direction.
Some of the positives include:
- Growth in exports.
- Companies are beginning to invest. Wells Fargo notes the gain in equipment and software spending.
Some negatives:
- Slow take on of employment.
- Personal savings rate will increase from low levels, which means lower consumer spending.
There seems some consensus that the recovery will continue, but at a very low pace.
US market valuations suggest a sideways move
However growth is measured, be it GDP or sales, for investors it should ultimately be about company earnings and the value that others are placing on these earnings. Prices that companies are transacted at is a function of their earnings and the earnings multiple that buyers and sellers are willing to transact at.
We know that at times when investors are enthusiastic, they are willing to pay exorbitant prices for the same earnings, while at other times they become nervous, resulting in a deluge of sellers and lower valuations.
At the same time company earnings do not move up in a straight line. Standard and Poors measures the consolidated earnings of all the companies that comprise the S&P500. On a trailing 12 months basis these earnings started 2009 at 14,88 after having declined substantially over the previous year.
During 2009, the annual 12-month number declined to 6,86 in March before slowly climbing to 9,19 in July and then up more sharply to the December number of 48,17.
On these 12-month trailing earnings the S&P500 at the current level of almost 1 100 is trading on a PE of 23 times
Using the Graham and Dodd methodology, which smoothes earnings over 10 years, produces a graph that more clearly presents the volatility in the price paid for the earnings as opposed to the volatility in the earnings themselves. (source: dshort)
The average price-to-earnings ratio using 10-year average earnings has been in the order of 16,3 times.
This ratio is currently running at 20 times having dropped to 13,4 times in March 2009. It’s evident from this long-term valuation graph that the PE multiple is mean reverting, trending over time from low to high multiples and back again.
Using this calculation, the major high was in 1999 at multiples of 44,2 times. Quite simply, speculators having acquired US shares at those expensive prices have received a 10-year return to -0,8% per annum.
Over the last 10 years from the 1999/2000 market peak, valuations have more than halved, but are still higher than the longer run average. Earnings should still pick up, which will support these valuations.
According to GMO, the S&P500 is worth about 850, which on current earnings is a more realistic PE of 17,7 times. Having moved up so rapidly to about 1 100, it may tread water for a while.
www.seedinvestments.co.za