Market Pulse: A rising multiple on rising earnings?
October 9, 2013
Recently Deutsche Bank's market strategist (Greg Poole) said that even with an impending debt ceiling fight he is still a buyer. Three reasons:
1. Price-earnings multiples will continue to expand. Historically the S&P 500 has traded with a P-E ratio of 15-16 and on that basis it appears to be fairly valued today. But when interest rates are low, as they are now, the market's P-E has been 17-18. So there is room for multiple expansion. Poole notes that ratios usually expand just ahead of an increase in earnings. That leads me to reason number two.
2. European economies are coming out of recession and slowly gathering strength (OK, very slowly). China's growth rate has bottomed and it, too, is showing more strength. Same for the economy here. Yes, the jobs picture is very weak, but it's gradually improving. Balance sheets are stronger than ever, dividends are rising and management is increasingly optimistic.
3. Central banks are super-accommodative and will remain so. There is an old saying, "Don't fight the Fed," and that's been good advice for decades and will be. Japan is beginning a massive QE program and the head of the European Central Bank said that more accommodation would be there, if needed. Rising rates here and overseas are far over the horizon.
Does all this sound familiar? It should. I've been writing about these themes all year and added a few more. One is still the market's driving force. TINA, There Is No Alternative.
Stocks are the most attractive asset class. Real estate is unworkable for most investors. Commodities are too risky. Gold produces no income and it's in a bear market. Treasurys will lose ground fast if (make that when) interest rates rise, as will better-grade corporates.
Stocks are the best choice, especially those that have attractive yields and raise their payout every year. I recommend many.
Bottom line: Stocks will do well even if interest rise along with the economy because profits will be growing, too. Putting a higher price (the "P") on rising earnings (the "E"), by definition, is multiple expansion.
Multiples expanded this year as prices rose while earnings stagnated. Now rising earnings will do their part. A rising multiple on rising earnings? Sounds good to me.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.