Earn Baby Earn

18/01/2013 at 4:54 pm

2013 has barely begun. With major stock indices some 3-5% higher already for the year to date it is obvious that it has begun with a bang.

Confidence has been improving for some time, taking valuations with it. At the end of the year the MSCI World Index of developed-world stock markets carried a historic p/e ratio of 16x. At the same time, consensus earnings growth for the index (based on analyst estimates aggregated by Bloomberg) is forecast to rise by 23% this year. If that can be delivered, current pricing doesn’t look too demanding.

Turning to the US in particular, as of today 67 S&P 500 index members have reported earnings for Q4 2012. Share weighted EPS are up 31% on the previous year. All that growth comes from financials: ex-financial EPS are currently down slightly (-0.4%).

Overall, earnings are forecast to have grown 3.8% on Q4 2011 by the time the last index constituent reports. Unsurprisingly that number has risen slightly since the data began to come in, and if the pace doesn’t slacken too suddenly will be revised up again.

There are a number of reasons why we might expect company earnings to do well – and to do better than nominal American GDP. Most obviously, there is room for margin improvement. Some of this may be attributable to manager brilliance; some is certainly attributable to new lows for corporate interest rates (with the BoA ML US Corporate Index recently yielding a record 2.7%), and lower effective tax rates over the last few years.

Whatever the reasons, however, EPS growth of 31% is remarkable. It appears highly unlikely to be sustained at that level as more reports come in. But even if we do see “only” 3.8% on the year to Q4, and similar data this year, robust earnings growth for the US and for the developed world as a whole begins to look perfectly plausible.

There are risks out there, as always. The sudden optimism over US politics and Japanese growth may be premature. It seems as if the European crisis is being disregarded now too. Though it has yet to push pricing into uncomfortable territory, there is the scent of complacency in the air.

After the disappointments of recent years we wish the relief rally well. Whatever happens to sentiment, sustained earnings growth would give it important support.


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