Corporate balance sheets in the U.S. are in phenomenal condition. Rarely, if ever, have companies had so much net cash [cash minus debt]. Debt levelshave come down at some companies, but others are taking advantage of cheap money to borrow. Much of this money will be used to fund capitalspending, but a good deal of it will be returned directly to investors in the form of share repurchases and dividends, as well as merger-and-acquisitionactivity. People expected M&A to pick up dramatically last year, which didn't happen. But the pieces are in place for transactions to occur now.
Which pieces are you referring to?
First, equity valuations are appealing. Second, market volatility is down. The volatility of theStandard & Poor's 500 is below the six-year average. That makes corporate managers and investors morecomfortable.Now, let's look more closely at some standard valuation models. Despite some of the grouchiness weoften hear at this table, U.S. stock prices have risen for the past four years. Stocks are near previousrecords, but valuations are lower because earnings have risen. If we run the Fed model [a comparison of the stock market's earnings yield with the yield on long-term Treasury bonds] on the back of anenvelope, it suggests fair value at year-end 2013 for the Standard & Poor's 500 would be 1750, compared with about 1470 now. If we use a dividend-discount model or a discounted-cash-flow model, we get asomewhat lower fair-value estimate. But keep in mind that return on equity in the U.S. is runningaround 14% for S&P companies, significantly higher than anywhere else in the world. ROE is under 10%for large companies in Europe, and it is just 5% for the companies in Japan's Topix index. Equity valuations in the U.S. don't reflect fully the improvement in the economy and corporate finances.
What is your S&P 500 earnings estimate for 2013?
Consensus estimates for earnings growth are on the order of 12% to 13% this year and next. Corporate performance has diverged from theeconomy's performance for many years, and that could continue. Companies in the S&P 500 are increasing their exposure to other parts of the world,not just for production purposes, but more important, in terms of end demand.
Abby, that's an incredibly bullish earnings forecast, especially if we are talking about gross domestic product of 1% or 2% in Europe, and 2% or3% in the U.S. I hope you are right, but when I look at the data, it is tough to connect the math dots. I have trouble getting to a low-teens rate of earningsgrowth.
What do you get to?
I get to 5%, 6%, 7% for this year.
Time out, people. Let's try to analyze why earnings have done so well in recent years. Corporate profits have come at the expense of labor. Wages as a percentage of GDP have declined to 54% from 59% in the past 10 years. That trend would have to continue for earnings to keep going up. Also, 30% to 35% of earnings growth in the past five years has come from lower interest expense. Most of you probably would agree that is coming to anend, as well. Corporations have to sell their products to somebody. They can't benefit when that somebody has depressed wages and high leverage. Atsome point the game begins to change. A forecast of 12%-to-13% earnings growth under such circumstances is not only extreme but almost farcical.
I gave you bottom-up estimates [industry analysts' estimates]. Our top-down number [market strategists' estimates] is lower, but still in themid- to high single digits. That is much better than many people, Goldman Sachs included, felt 12 months ago.
You are overly ebullient. Last year at this time, people expected the S&P 500 to earn more than $110. Earnings are likely to come in at $98 to$99 for 2012. In the third quarter, corporate earnings were down 5%. In the quarter that just ended, they will be up about 6%. The original earningsestimates don't hold water. Also, operating profit margins for the S&P 500 peaked in the third quarter of 2011, at 9.51%. There are no more economiesof scale to be gleaned. If you think nominal GDP growth is going to be around 4%, there is no way you are going to get 12% or 13% earnings growth.
There is huge room for disappointment in the equity market.
: We see 2.5% growth in GDP this year and about 3% by the end of next year. There will besubstantial fiscal drag [restraint on economic expansion caused by higher taxation] on the order of $200 billion, starting now.
Can I get a more realistic view of the world, please? The U.S. continues to have a "new normal"economy, with annual growth of 2% or less. Growth rates in the rest of the developed world are evenlower. There are several reasons for this. There is too much debt, and the ongoing delevering processcreates the fiscal drag we just talked about. There is also a demographic issue: The population is gettingolder. The baby boomers are receiving more Social Security payments. Japan is way ahead of us in aging, but it is a trend throughout the developed world. Third, de-globalization contributes to slowing growth.Nations are taking care of themselves. They are setting up trade barriers and engaging in currency warsand other practices that are destructive to growth.In the credit markets, when money yields close to zero, it is destructive, not constructive. Net interestmargins at financial institutions come under threat. What does
[MS] do? The company recently said it would lay off 1,600 people andclose branches. Companies pull in. Delevering starts with the financial complex and expands to the real economy. This is not the old economy, whereleverage could produce 10% to 15% earnings growth every year. We have to adjust to a new world in which returns have been driven down to perhaps3%, 4%, and 5%, as opposed to 10% to 15%.
Jennifer Altman for Barron's
Like many on Wall Street, the Roundtable panelistsare excited by the prospect of American energyindependence as a result of massive shale-gasdiscoveries, mostly in the Midwest. Says MerylWitmer (far right): "A lot of jobs are being created, andthey will lead to other jobs. The natural-gas boom is ahuge deal for the U.S."
Enlarge ImageJennifer Altman for Barron's
Brian Rogers (second from right): "A combination ofdecent economic performance, reasonablevaluations, and decent dividend activity suggestsstocks could do well this year. Stocks are attractiverelative to fixed income."
2013 Barron's Roundtable, Part One - Barrons.comhƩp://online.barrons.com/arƟcle/SB5000142405274870484320457824...3 of 121/20/2013 12:26 PM