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S&P 500 2011 year-end target remains 1400, 12-month target raised to 1450 from 1400
12-month target raised on time value and conviction in 2012 EPS being ~$100 barring recession
S&P 500 EPS & Target PE
EPS estimates: 2011 $97, 2012 $104
Target PE is 13.5x, lower than our usually assigned fair PE of 14-16x on normalized EPS
Proxy for fair forward S&P 500 PE = 1 / fair real return (ex. inflation) on long-term S&P 500 ownership
Our 1400 year-end target is EPS scenario probability weighted to acknowledge downside tail risks
Sector Strategy:
Overweight: Technology, Energy, Materials, Industrials
Marketweight: Financials, Utilities
Underweight: Health Care, Consumer Discretionary, Consumer Staples, Telecom
Key views and expectations:
No US recession – but balance sheet repair and government policy angst weigh on GDP growth for extended period
Global economy stays healthy (4.5%) in 2012, despite weak US (2.3%) and European (1.4%) growth, thanks to Asia
In correction territory (under 1230), S&P 500 priced for a mild to avg. US recession. ~1200/~14x implies ~$85 2012 EPS
No Fed Funds rate hikes until 2014, 10yr Treasury yield 3% at 2011 end, 4% at 2012 end and below 5% until 2015
Oil prices stay high (WTI $85-100/bbl) but do not spike to new records – high commodity prices stimulate capex
US business spending on equipment and software to rise at healthy pace, which benefits Industrials and Technology
2012 S&P EPS growth of 7% outpaces US GDP, led by S&P foreign (~40%) and business spending (~25%) exposures
The huge disconnect between PE ratios and interest rates will spur acquisitions, share repurchases and dividend hikes
We prefer high dividend growth stocks over high dividend yield stocks. S&P 500 DPS estimates: 2011 $28, 2012 $38
Overweight sectors most foreign and B2B exposed, underweight sectors most consumer and govt. spending exposed
Discipline & courage earn gains – S&P 500 typically rallied 15%+ Sep-Jan when priced for a recession that didn’t come
Things we say almost everyday…
“S&P 500 PE to expand as fear gives way to the math of low interest rates”
Record high EPS and record low interest rates are bullish. The S&P 500 remains ~25% below its 2007 high.
2011E S&P EPS of $97 represents new peak EPS for the S&P 500. 2012E S&P EPS is $104, which is 7% growth.
Healthy commodity and capital goods demand/prices to keep EPS growth healthy, weak GDP to keep interest rates low.
The S&P PE is under 12x, putting the EPS yield at about 8.5%. The offered equity risk premium is a record 800+ bp.
“S&P 500 year-end target remains 1400 owing to tail risks, but fair intrinsic value is ~1550”
Year-end S&P target remains 1400 as we are convinced that EPS will be $100+ in 2012 provided US averts recession.
In correction, the S&P 500 is priced for a mild to avg. US recession. Only bear market without recession was 1987 crash.
The S&P 500 typically rallies by 15%+ from September through January when priced for a recession that doesn’t come.
Yield starved institutional investors and asset allocation funds likely buy mega-cap stocks as S&P EPS proves resilient.
“The S&P 500 is not US GDP”
Two-thirds of S&P 500 non-financial profits are from manufacturing whereas two-thirds of US consumption is services.
“40% of S&P 500 profits come from abroad” (25% foreign developed [DM] economies, 15% emerging [EM] economies)
15 years ago, 20% of S&P profits were foreign, thus “the S&P is successfully replicating its businesses around the world.”
In aggregate, “S&P foreign margins are higher than domestic margins.” Most foreign sales are at high margin companies.
The S&P 500 can benefit from the best of the DM and EM worlds: Low interest rates from DM and good growth from EM.
“S&P 500 profits benefit from strong commodity prices”
As long as higher commodity prices don’t cause a recession, higher commodity prices are a net positive to S&P EPS.
Most of the S&P 500 either 1) produces commodities (Energy, Materials); 2) supplies commodity producers (Industrials);
or 3) does not heavily use commodities (Tech, Healthcare, Financials, and Telecom).
Emerging economy growth mopped up the excess capacity in the global commodity complex, which depressed heavy
industry profits and investment spending during the 1990’s.
S&P Energy, Industrial, and Materials sectors are very sensitive to EM growth via commodity demand, so EM growth
drives more than 15% of S&P profits via commodity prices and related capital goods demand.
Every $5/bbl increase in the average oil price for the year boosts S&P 500 EPS by $1/sh.
Total commodity costs, including value-add processing, are only 15% of total operating costs.
“S&P 500 companies have strong linkages to global end demand”
70% of US GDP is household consumption, but only 30% of US GDP is retail spending (22% discretionary retail) and
“only 15% of S&P 500 profits are from consumer discretionary spending.”
20-25% of S&P profits are from business investment spending (think Tech, Industrials)
Rising global commodity and capital goods demand drives US investment spending, not US household consumption.
Half of US non-construction business investment spending is Technology (productivity) related and a third is heavy
industrial equipment which has strong linkages to international end demand.
BofAML Economists forecast US equipment and software spending in 2012 to grow at 7%, 3x the rate of US GDP.
“S&P 500 mid-cycle normal margins are higher than history”
S&P 500 mid-cycle normal net margins have shifted up from about 7% in the mid and late 1990s to about 9% now.
The 200bp of net margin expansion came from: 100bp from lower effective tax rates due to higher foreign profits, 25bp
from lower net interest expense due to less debt usage, and 75bp from operating margin improvements, mostly at Tech.
By sector, Tech has contributed 150bp and Energy has contributed 40bp of the 200bp total net margin improvement.
Many investors confuse margin cyclicality (margins fall in recessions) as evidence of secular margin mean reversion.
“China’s growth slowly shifting from construction-led to consumption-led will benefit many
S&P 500 Industrial and Technology as well as certain Consumer and Health Care companies”
China was export driven, now it is investment (construction) driven; it will slowly become consumer driven.
o China has built many airports, highways, and cities, yet it still needs many more planes, trucks, and jet/diesel fuel.
More urban consumers will desire more household durable and consumable products.
o Demand for construction oriented commodities will eventually slow significantly, but consumable commodity
(energy, foodstuffs, chemicals, etc.) demand growth is likely to stay relatively robust for an extended period.
Rapid China growth tends to absorb what westerners see as “excess capacity”; China builds for growth and surge usage.
S&P multinationals offer value-added plays on emerging economy growth (EM indices = lots of banks and commodities).
“We prefer high dividend growth stocks over high dividend yield stocks”
High-yielding dividend stocks are attractive bond substitutes, but we prefer stocks with strong dividend growth potential.
S&P 500 dividend payouts are very low vs. history; we forecast quarterly S&P dividends/sh to increase 50% by 2012-end.
Yield starved investors want higher dividend payouts. We advocate a 35-40% S&P payout ratio, up from today’s 25-30%.
Higher dividends would help restore a more fundamental investor mindset and crystallize the S&P’s higher intrinsic value.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
S&P 500 2011 year-end target remains 1400, 12-month target raised to 1450 from 1400
12-month target raised on time value and conviction in 2012 EPS being ~$100 barring recession
S&P 500 EPS & Target PE
EPS estimates: 2011 $97, 2012 $104
Target PE is 13.5x, lower than our usually assigned fair PE of 14-16x on normalized EPS
Proxy for fair forward S&P 500 PE = 1 / fair real return (ex. inflation) on long-term S&P 500 ownership
Our 1400 year-end target is EPS scenario probability weighted to acknowledge downside tail risks
Sector Strategy:
Overweight: Technology, Energy, Materials, Industrials
Marketweight: Financials, Utilities
Underweight: Health Care, Consumer Discretionary, Consumer Staples, Telecom
Key views and expectations:
No US recession – but balance sheet repair and government policy angst weigh on GDP growth for extended period
Global economy stays healthy (4.5%) in 2012, despite weak US (2.3%) and European (1.4%) growth, thanks to Asia
In correction territory (under 1230), S&P 500 priced for a mild to avg. US recession. ~1200/~14x implies ~$85 2012 EPS
No Fed Funds rate hikes until 2014, 10yr Treasury yield 3% at 2011 end, 4% at 2012 end and below 5% until 2015
Oil prices stay high (WTI $85-100/bbl) but do not spike to new records – high commodity prices stimulate capex
US business spending on equipment and software to rise at healthy pace, which benefits Industrials and Technology
2012 S&P EPS growth of 7% outpaces US GDP, led by S&P foreign (~40%) and business spending (~25%) exposures
The huge disconnect between PE ratios and interest rates will spur acquisitions, share repurchases and dividend hikes
We prefer high dividend growth stocks over high dividend yield stocks. S&P 500 DPS estimates: 2011 $28, 2012 $38
Overweight sectors most foreign and B2B exposed, underweight sectors most consumer and govt. spending exposed
Discipline & courage earn gains – S&P 500 typically rallied 15%+ Sep-Jan when priced for a recession that didn’t come
Things we say almost everyday…
“S&P 500 PE to expand as fear gives way to the math of low interest rates”
Record high EPS and record low interest rates are bullish. The S&P 500 remains ~25% below its 2007 high.
2011E S&P EPS of $97 represents new peak EPS for the S&P 500. 2012E S&P EPS is $104, which is 7% growth.
Healthy commodity and capital goods demand/prices to keep EPS growth healthy, weak GDP to keep interest rates low.
The S&P PE is under 12x, putting the EPS yield at about 8.5%. The offered equity risk premium is a record 800+ bp.
“S&P 500 year-end target remains 1400 owing to tail risks, but fair intrinsic value is ~1550”
Year-end S&P target remains 1400 as we are convinced that EPS will be $100+ in 2012 provided US averts recession.
In correction, the S&P 500 is priced for a mild to avg. US recession. Only bear market without recession was 1987 crash.
The S&P 500 typically rallies by 15%+ from September through January when priced for a recession that doesn’t come.
Yield starved institutional investors and asset allocation funds likely buy mega-cap stocks as S&P EPS proves resilient.
“The S&P 500 is not US GDP”
Two-thirds of S&P 500 non-financial profits are from manufacturing whereas two-thirds of US consumption is services.
“40% of S&P 500 profits come from abroad” (25% foreign developed [DM] economies, 15% emerging [EM] economies)
15 years ago, 20% of S&P profits were foreign, thus “the S&P is successfully replicating its businesses around the world.”
In aggregate, “S&P foreign margins are higher than domestic margins.” Most foreign sales are at high margin companies.
The S&P 500 can benefit from the best of the DM and EM worlds: Low interest rates from DM and good growth from EM.
“S&P 500 profits benefit from strong commodity prices”
As long as higher commodity prices don’t cause a recession, higher commodity prices are a net positive to S&P EPS.
Most of the S&P 500 either 1) produces commodities (Energy, Materials); 2) supplies commodity producers (Industrials);
or 3) does not heavily use commodities (Tech, Healthcare, Financials, and Telecom).
Emerging economy growth mopped up the excess capacity in the global commodity complex, which depressed heavy
industry profits and investment spending during the 1990’s.
S&P Energy, Industrial, and Materials sectors are very sensitive to EM growth via commodity demand, so EM growth
drives more than 15% of S&P profits via commodity prices and related capital goods demand.
Every $5/bbl increase in the average oil price for the year boosts S&P 500 EPS by $1/sh.
Total commodity costs, including value-add processing, are only 15% of total operating costs.
“S&P 500 companies have strong linkages to global end demand”
70% of US GDP is household consumption, but only 30% of US GDP is retail spending (22% discretionary retail) and
“only 15% of S&P 500 profits are from consumer discretionary spending.”
20-25% of S&P profits are from business investment spending (think Tech, Industrials)
Rising global commodity and capital goods demand drives US investment spending, not US household consumption.
Half of US non-construction business investment spending is Technology (productivity) related and a third is heavy
industrial equipment which has strong linkages to international end demand.
BofAML Economists forecast US equipment and software spending in 2012 to grow at 7%, 3x the rate of US GDP.
“S&P 500 mid-cycle normal margins are higher than history”
S&P 500 mid-cycle normal net margins have shifted up from about 7% in the mid and late 1990s to about 9% now.
The 200bp of net margin expansion came from: 100bp from lower effective tax rates due to higher foreign profits, 25bp
from lower net interest expense due to less debt usage, and 75bp from operating margin improvements, mostly at Tech.
By sector, Tech has contributed 150bp and Energy has contributed 40bp of the 200bp total net margin improvement.
Many investors confuse margin cyclicality (margins fall in recessions) as evidence of secular margin mean reversion.
“China’s growth slowly shifting from construction-led to consumption-led will benefit many
S&P 500 Industrial and Technology as well as certain Consumer and Health Care companies”
China was export driven, now it is investment (construction) driven; it will slowly become consumer driven.
o China has built many airports, highways, and cities, yet it still needs many more planes, trucks, and jet/diesel fuel.
More urban consumers will desire more household durable and consumable products.
o Demand for construction oriented commodities will eventually slow significantly, but consumable commodity
(energy, foodstuffs, chemicals, etc.) demand growth is likely to stay relatively robust for an extended period.
Rapid China growth tends to absorb what westerners see as “excess capacity”; China builds for growth and surge usage.
S&P multinationals offer value-added plays on emerging economy growth (EM indices = lots of banks and commodities).
“We prefer high dividend growth stocks over high dividend yield stocks”
High-yielding dividend stocks are attractive bond substitutes, but we prefer stocks with strong dividend growth potential.
S&P 500 dividend payouts are very low vs. history; we forecast quarterly S&P dividends/sh to increase 50% by 2012-end.
Yield starved investors want higher dividend payouts. We advocate a 35-40% S&P payout ratio, up from today’s 25-30%.
Higher dividends would help restore a more fundamental investor mindset and crystallize the S&P’s higher intrinsic value.
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