US equities forecast to advance as recovery grows

Analysts say Wall Street will ride strength of economic recovery, with the S&P 500 Index targeted to end the year at a record high

PUBLISHED : Tuesday, 09 July, 2013, 12:00am
UPDATED : Tuesday, 09 July, 2013, 5:23am

The same equity analysts who lowered second-quarter profit growth predictions for firms in the United States to almost nothing for this year are raising price forecasts, convinced the economy is growing fast enough to lure more investors and boost valuations.

Standard & Poor's 500 Index earnings rose 1.8 per cent in the past quarter, down from a projection of 8.7 per cent six months ago, according to more than 11,000 analyst estimates.

At the same time, share-price targets are rising at the fastest rate in two years.

The S&P 500, which closed at 1,631.89 points on Friday, will increase 8.9 per cent to a record 1,777.91 should the forecasts prove accurate.

Bulls say expectations for higher valuations show analysts share Federal Reserve chairman Ben Bernanke's view that the economy may gather enough momentum to expand on its own. Getting to their target would raise the index's earnings multiple to 16.4, still about 12 per cent lower than its 25-year average.

Bears say price appreciation without profit gains shows the five-year bull market is fading and declines are inevitable.

Second-quarter earnings season began yesterday.

"There's a tight relationship between confidence and multiples," said Joseph Tanious, a global market strategist at JP Morgan Funds. "Confidence at these levels, while still depressed, is clearly rising. You have an improving US economy, albeit at a slow pace."

Stocks rose last week, with the S&P 500 climbing 1.6 per cent after employers added 195,000 jobs last month and manufacturing rose more than forecast. While the index has fallen 2.2 per cent since the May 21 record, it is up 14.4 per cent for the year to date.

Even as the S&P 500 rallied 60 per cent in the past three years, its price-earnings ratio remained below the long-term average of 18.6, according to data going back to 1988. Valuations have held steady as profit growth matched gains in share prices since the bull market began in March 2009.

Reaching analyst price forecasts would send the index more than 6.5 per cent above the record high of 1,669.16 points on May 21. Operating profits projected to reach a record US$108.40 a share this year would give the index a valuation of 16.4, compared with 17.5 when the market peaked in October 2007.

"If we were to say people were dipping their toe in the water on the economy a few years ago, now they are mid-thigh," said Joe Kinahan, the chief derivatives strategist at TD Ameritrade.

"There is every reason to believe that the multiples should also increase."

After three years of growth, earnings increases are slowing. Income in the S&P 500 Index rose an average of 4.3 per cent in each of the past five quarters, compared with the 28 per cent average for 2010 and 2011.