Global CIO Commentary by Scott Minerd
Winding the clock back to the fall of last year, it was clear that U.S. equities, and financial stocks in particular, were a strong buy and warranted increased allocations where appropriate. I gave a top-end target estimate of around 1720 for the S&P 500 at the time. Today, my long-term view of U.S. equities remains bullish, and U.S. equities could easily be 30-40 percent higher than today’s levels within two to three years. Having said that, for a number of reasons, now does not appear to be a favorable entry point. Depending on their time-horizons, investors, many who have large unrealized gains, may want to consider booking some of those gains and reducing their equity exposure.
Historically, markets that have rallied as aggressively as U.S. equities since November 2012 (an increase of 25 percent), pause or correct to digest their advances. Also, earnings among U.S. companies have flattened and could turn negative within two to three quarters, meaning further upside can only come from multiple expansion. Of the 19 percent rise in stocks year-to-date, 16 percent has already come from multiple expansion. Finally, it appears GDP growth could be entering a soft patch as we work through a number of short-term issues such as the headwinds in housing, reduced growth in China, the full impact of the sequester, and the budget and debt ceiling debates that will take place in Washington in the third quarter – all of which will put downward pressure on stock prices. The near-term outlook for equities makes now a good time to consider the old Wall Street adage, “Nobody ever lost money by taking a profit."
Multiple Expansion Driving the Rally in U.S. Equities
The P/E multiple, defined as the ratio of price to trailing 12-month earnings, has been the main driver of the rally in U.S. equities over the past two years. The S&P 500 index has increased by over 34 percent since the beginning of 2011, of which 28 percent has come from multiple expansion. During the same period, growth in corporate earnings has slowed. The trailing 12-month earnings for S&P 500 companies rose 2.4 percent in 2012 and another 2.5 percent for the first seven months of this year, registering the slowest earnings growth in non-recession years since 1998. Without renewed earnings growth, a continued rally in stocks driven by multiple expansion may be not sustainable.
S&P 500 RETURN AND THE BREAKDOWN OF CONTRIBUTION
Source: Bloomberg, Guggenheim Investments’ Calculation. Data is annual frequency with latest 2013 data updated as of 8/7/2013.
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