Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Download
Standard view
Full view
of .
Look up keyword
Like this
5Activity
0 of .
Results for:
No results containing your search query
P. 1
U.S. Equity Strategy (What's Driving the Equity Market) - September 14, 2012

U.S. Equity Strategy (What's Driving the Equity Market) - September 14, 2012

Ratings: (0)|Views: 1,382|Likes:
Published by dpbasic
September 14, 2012 - TD Waterhouse - U.S. Equity Market Analysis by Ryan Lewenza and Team
September 14, 2012 - TD Waterhouse - U.S. Equity Market Analysis by Ryan Lewenza and Team

More info:

Categories:Types, Maps
Published by: dpbasic on Sep 16, 2012
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

09/16/2012

pdf

text

original

 
 
Report prepared by:
Ryan Lewenza, CFA, CMTV.P., U.S. Equity Strategist
This Document is for distributionto Canadian clients only.Please refer to Appendix A in thisreport for important information.
Highlights
 
From the June low of 1,266.74, the S&P 500 Index (S&P 500) is up over 13%,which has entirely been driven by multiple expansion. As we have outlined inrecent publications, it’s our belief that the move higher in the S&P 500, due to anexpansion in valuation multiples, has been driven in part by the prospect of additional central bank liquidity.
 
The European Central Bank (ECB) followed through on its strong signals of additional stimulus, with President Mario Draghi announcing that the ECB wouldlaunch a new bond buying program on September 6
th
. The Federal Reserve (Fed)then followed up on September 13
th
by announcing yet another bond buyingprogram, which will see the Fed buy $40 billion of mortgage-backed securities per month, with an open-ended mandate. This action led to a strong rally in the equitymarkets, with the U.S. equity market rallying over 1.5% on the day, being driven bycontinued P/E expansion.
 
 As history has shown, equity markets perform well in periods of additionalmonetary stimulus, such as QE, which we believe could occur with the latest roundas well.
 
We are introducing our 2013 S&P 500 earnings forecast of $102.25, which if realized, would represent a significant slowdown in corporate profit growth nextyear. Based on our estimates, profit growth would slow to 3.3% in 2013, comparedto 7.1% expected for 2012, and the 15.2% growth seen in 2011. The bottom-upconsensus estimate for 2013 stands at $115.43 (11.7% Y/Y growth), but webelieve the current consensus estimate is too high, and is likely to be revised lower in the coming months
 
 All told, our EPS models point to continued healthy earnings in 2013, however webelieve earnings will come in below the current optimistic consensus estimates,and that U.S. earnings could peak in 2013. If correct, further upside in equity priceswill have to be driven by continued P/E expansion, as the support of higher earnings growth begins to wane.
S&P 500 2013 EPS ForecastVIX Hits New Low Capturing Investor Complacency
September 14, 2012
S&P 500 Earnings Forecasts20112012E2013E
 
Economic Regression Model $96.54$99.00$102.25Y/Y Growth 15.2%2.5%3.3%Normalized Earnings Model $96.54$98.35$99.54Y/Y Growth 15.2%1.9%1.2%Bottom Up Consensus $96.54$103.38$115.43Y/Y Growth 15.2%7.1%11.7%
Source: Portfolio Advice & Investment Research. As of September 12, 2012
 
U.S. EquityStrategySeptember 14, 2012Page 2
What’s Driving the Equity Market? P/E or the E?
Equity prices are driven by their component parts – valuation multiples (i.e. P/E’s) or earnings. When stocks move higher it is due to multiple expansion and/or an increase in earnings. From its June low of 1,266.74 the S&P 500 is up over 13%,which has entirely been driven by multiple expansion. As seen in Exhibit 1, the forward P/E for the S&P 500 has increasedfrom 12.2x in early June, to its current 13.9x. As we have outlined in recent publications, it’s our belief that the movehigher in the S&P 500, due to an expansion in valuation multiples, has been driven in part by the prospect of additionalcentral bank liquidity. The European Central Bank (ECB) followed through on its strong signals of additional stimulus, withPresident Mario Draghi announcing that the ECB would launch a new bond buying program, allowing for unlimitedpurchases of sovereign bonds in the secondary market on September 6
th
. While there are some conditions attached tothis program, we view this as a form of quantitative easing (QE), which is supportive of equity prices. The FederalReserve (Fed) then followed up on September 13
th
by announcing yet another bond buying program, which will see theFed buy $40 billion of mortgage-backed securities per month, with an open-ended mandate. This action led to a strongrally in the equity markets, with the U.S. equity market rallying over 1.5% on the day, being driven by continued P/Eexpansion.On the earnings front, we have witnessed a marked deceleration in earnings growth, with year-over-year (Y/Y) earningsgrowth dropping from 9.7% in Q1/12 to flat growth in Q2/12 – the weakest showing since 2009. Moreover, expectationsfor future earnings growth continue to come down (Exhibit 1). In the summer of 2011, the consensus estimate for 2012full-year S&P 500 earnings was $114. Currently, the consensus estimate is for 2012 full-year earnings of $103.38, whichis down 10% from summer 2011, and 1.5% from the $105 expected in May 2012. As the global economy continues toweaken, analysts are trimming earnings estimates due to a more cautious outlook, which has led to the negative earningsrevisions.We believe the strong rally in equity markets has been driven by the prospect, and now reality, of additional central bankliquidity. The gains have been driven by P/E expansion rather than earnings growth, as sentiment improves based on the“Bernanke/Draghi put”. As history has shown, equity markets perform well in periods of additional monetary stimulus,such as QE, which we believe could occur with the latest round as well. However, as we cover on the following page,equities without the support of strong and increasing earnings could be susceptible to pullbacks, once the stimulus wearsoff.
Exhibit 1: Market Gains Are Being Driven by Multiple Expansion against Declining Earnings Expectations
S&P 500 Index
1,0501,1501,2501,3501,450Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12
1011121314
S&P 500 (LHS)Forward P/E (RHS)
Source: Bloomberg Finance L.P. As of September 10, 2012Market advance has beendriven by PE expansion rather than earnings growth.
S&P 500 Consensus EPS Estimates
$90$95$100$105$110$115$120$125Jan-10Apr-10Jul-10Oct-10Jan-11Apr-11Jul-11Oct-11Jan-12Apr-12Jul-12
Source: Bloomberg Finance L.P. As of Septmeber 10, 201220112012E2013EConsensus EPS estimatescontinue to decline.
 
U.S. EquityStrategySeptember 14, 2012Page 3
2013 Earnings Forecast
With that said, we are introducing our 2013 S&P 500 earnings forecast of $102.25, which if realized, would represent asignificant slowdown in corporate profit growth next year. Based on our estimates, profit growth would slow to 3.3% in2013, compared to 7.1% expected for 2012, and the 15.2% growth seen in 2011 (Exhibit 2). The bottom-up consensusestimate for 2013 stands at $115.43 (11.7% Y/Y growth), but we believe the current consensus estimate is too high, andis likely to be revised lower in the coming months. Our more conservative forecast is based on the following assumptions:
 
Our primary earnings model is based on a macroeconomic regression model, in which we assume a below-trend GDP growth rate of 2% for 2013.
 
Given our continued low-growth expectations for 2013, we expect top-line revenue growth for the S&P 500 toslow to 3%, from the expected 5% growth in 2012.
 
Net income profit margins, which should remain healthy, could decline in 2013. Based on the currentestimate for 2013, sell-side analysts project net income profit margins to expand from the current 9.25%, to10.25% in 2013. As seen in Exhibit 2, current profit margins appear unsustainable in the 9-9.5% range, whichis well above the 7.7% average seen since 1998. With profit margins currently near-record levels, we fail tosee how they could expand further, and as such, incorporate a small margin contraction in our 2013 EPSforecast. However, it is important to note that significant margin compression is unlikely to occur until we seea large uptick in employment and wages, as employee compensation accounts for roughly two-thirds of thetotal production costs.With our belief that the earnings cycle is beginning to mature and could peak in 2013, we updated our normalizedearnings model, to see what it is forecasting for 2013. Normalized earnings help to smooth out earnings, by adjusting for the cyclical ups and downs, over the business cycle. We use an 8-year period to normalize earnings, as it averagesgrowth adjusted earnings over roughly two business cycles. Based on this model, we project normalized earnings in 2013at $99.54, which is 2.5% below our base case 2013 EPS forecast. All told, our EPS models point to continued healthyearnings in 2013, however we believe earnings will come in below the current optimistic consensus estimates, and thatU.S. earnings could peak in 2013. If correct, further upside in equity prices will have to be driven by continued P/Eexpansion, as the support of higher earnings growth begins to wane.
Exhibit 2: Weaker Profit Margins In Part Explain our More Conservative S&P 500 2013 EPS Forecast
S&P 500 Earnings Forecasts20112012E2013E
Economic Regression Model $96.54$99.00$102.25Y/Y Growth 15.2%2.5%3.3%Normalized Earnings Model $96.54$98.35$99.54Y/Y Growth 15.2%1.9%1.2%Bottom Up Consensus $96.54$103.38$115.43Y/Y Growth 15.2%7.1%11.7%
Source: Portfolio Advice & Investment Research. As of September 12, 2012
 
S&P 500 Net Profit Margin
0%2%4%6%8%10%12%9899000102030405060708091011
Source: Bloomberg Finance L.P. As of September 12, 2012
7.7% is the average since 1998 
Net profit margins areunsustainably high at 9.25%.

Activity (5)

You've already reviewed this. Edit your review.
1 hundred reads
philia6571 liked this
BP liked this

You're Reading a Free Preview

Download
scribd
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->