S&P 500 in Cheapest Bull Market Since Reagan Trade 26% From Peak
Monday, 19 Nov 2012

The post-election rout in U.S. stocks has driven the Standard & Poor’s
500 Index down so far that it would have to advance 26 percent to
reach the valuation of bull markets since John F. Kennedy was in the
White House.

Investors have seen $806 billion erased from the value of American
equities since President Barack Obama was re-elected Nov. 6 in the
biggest decline since May. The combination of falling stocks and
rising profits as the economy recovers has left the S&P 500’s
price-earnings ratio below the ending level of eight of the nine bull
markets since 1962 and beneath the average of any since Ronald Reagan
was in power.

Bears say the 4.8 drop in the S&P 500 and valuations show investors
are losing confidence that Congress and Obama will reach a budget
compromise that would keep the recovery from stalling. Bulls,
including the top strategists at six Wall Street firms, say that the
declines are another reason to buy and that stock prices from Apple
Inc. to Dollar Tree Inc. are bound to improve as earnings increase.

“The stock market looks cheap because people are way too pessimistic
about what growth looks like for the next 10 years,” said Brian
Jacobsen, who helps oversee $208 billion as chief strategist at Wells
Fargo Advantage Funds and predicts the S&P 500 will rise 47 percent to
2,000 in 2014. “You can get big and rapid moves in the market when
expectations are so low.”

Jan. 1

Concern about the so-called fiscal cliff -- $607 billion of spending
cuts and tax increases that automatically go into effect Jan. 1 --
overshadowed better-than-estimated profit reports from Cisco Systems
Inc. and Home Depot Inc. last week, sending the S&P 500 down 1.5
percent to 1,359.88. Obama began face-to-face talks with top
Republicans and Democrats on Nov. 16 after he and House Speaker John
Boehner said they will work toward an agreement. Boehner and White
House Press Secretary Jay Carney described the meeting as
“constructive.”

Even as shares fall, strategists are optimistic about gains next year.
The S&P 500 will rally 17 percent to a record 1,585 by the end of
2013, according to the average forecast.

Douglas Kass, the founder of Seabreeze Partners Management Inc. in
Palm Beach, Florida, who recommended buying stocks at the March 2009
low says the benchmark gauge may rise 18 percent to 1,600 next year as
politicians reach a budget compromise and the economy continues to
expand.

‘Twice Shy’

“The No. 1 mistake that is being made is the old proverb, ‘Once
bitten, twice shy’,” Kass said in a Nov. 14 Bloomberg Radio interview
with Tom Keene. “Market participants today are incorrectly playing the
last war, which took place during the budget deliberations in August
of last year. Those fears are misplaced.”

Savita Subramanian of Bank of America Corp. says the index will rally
to 1,600 on rising corporate profits and diminishing concerns about
the global economy. John Stoltzfus, at Oppenheimer & Co., forecasts
the gauge will climb to 1,585 and Goldman Sachs Group Inc.’s David
Kostin estimates 1,575, based on support from the Federal Reserve’s
third round of bond purchases. Fed Chairman Ben S. Bernanke pledged in
September that the central bank will buy $40 billion of mortgage
securities a month until the U.S. labor market recovers.

Optimism is misplaced unless Obama and Republican leaders are able to
agree on measures to avoid the mandated cuts and tax increases,
according to James Bianco, president of Bianco Research LLC in
Chicago.

The $607 billion burden could cause the world’s largest economy to
shrink 0.5 percent next year, according to a Nov. 8 Congressional
Budget Office report.

‘More Pain’

“Up until the election day no one had priced in a fiscal cliff because
the thinking overwhelmingly on Wall Street was there wasn’t going to
be one,” Bianco said in a Nov. 14 Bloomberg Television interview.
“We’re only now starting to price it in and we’ve only been pricing it
in for a week. If we continue to keep our pencils down, there’s going
to be a lot more pain.”

The economy is recovering at the slowest post-recession rate since
World War II, as the housing market stagnated until this year and
unemployment stayed above 8 percent through August.

Lawmakers of both parties say they want to avoid the fiscal cliff’s
economic shock while addressing the deficit. Boehner said Nov. 16 that
Republicans are willing to consider revenue- raising measures in
exchange for spending cuts. Obama said tax rates should rise without
specifying that the top rate must return to the 39.6 percent
stipulated.

Below Average

While the S&P 500 has doubled since Obama first took office, the
index’s price-earnings ratio was lower than the 16.4 six-decade
average for 38 of the rally’s 46 months, as earnings surged, data
compiled by Bloomberg show.

The multiple is up 35 percent since March 2009, compared with the
average expansion of 55 percent in bull markets since 1962, Bloomberg
data show. For the past 2 1/2 years, the S&P 500 hasn’t climbed higher
than 16 times earnings, compared with the average ratio of 17.4 in
past rallies.

The valuation rose to a high of 13.8 from 7.3 during the first 15
months of the 1982 advance that pushed the S&P 500 up 229 percent,
according to data compiled by Bloomberg. In the 1990s rally led by
technology companies, it almost doubled to 28.5 during the eight
years.

‘Glum to Glee’

“As a country, we go from glum to glee and glum to glee over and over
again,” James Paulsen, the chief investment strategist at
Minneapolis-based Wells Capital Management, which oversees about $325
billion, said in a phone interview. “After the 2008 recession and the
tech bubble, we’re back at glum, so what comes next?” he said.
“Confidence, and the ability to rebuild it, is our biggest asset for
the future.”

Economists predict global GDP will increase 2.6 percent next year from
2.2 percent in 2012, the slowest since it contracted three years ago,
according to a survey by Bloomberg. The pace of U.S. growth will be 2
percent in 2013, down from 2.2 percent this year, according to the
median of 98 estimates.

The tumble since Obama defeated Republican candidate Mitt Romney, with
303 electoral votes to 206, pushed the benchmark gauge to 13.7 times
reported profits, lower than the 15.5 average ratio since March 2009,
according to data compiled by Bloomberg. Only one bull market since
1962 has ended with a lower valuation: the six-year cycle through 1980
in which the index gained 126 percent to 140.52, or 9.1 times profits.

Average Ratio

The ratio averaged 17.4 during the nine rallies and ended at about
19.9. Reaching the mean level would require a 26 percent gain in the
S&P 500, holding earnings constant, data compiled by Bloomberg show.
Should profits meet analysts’ 2013 projection, the index would need a
42 percent gain from the Nov. 16 closing price. Earnings are forecast
to climb to a record $110.80 a share next year, almost double what
companies posted in 2008, analyst estimates compiled by Bloomberg
show.

“Valuations are cheap given what we’ve seen in earnings,” said Hank
Smith, chief investment officer at Haverford Trust Co. in Radnor,
Pennsylvania. His firm oversees $6.5 billion in assets. “Corporate
America is strong, balance sheets are exceptionally strong and flush
with cash. We do not believe we’ll have a contraction in earnings next
year. We expect profit growth to re-accelerate in the second half of
2013.”

Apple Multiple

Apple, which has fallen 25 percent from its high of $702.10 on Sept.
19 traded at 11.9 times reported profits, a 14 percent discount to its
five-year average, data compiled by Bloomberg show. The ratio reached
a record 23.3 times income 2 1/2 years ago, even after the Cupertino,
California-based company posted record earnings in the first quarter.

Profits for Dollar Tree, which sells everything from toys to pet food
for $1 or less, will rise 24 percent in fiscal 2013, ending in
January, and 13 percent the next year, according to analyst estimates.
While the shares have almost tripled since March 2009, the
price-earnings ratio at 16.7 is 21 percent below the five-year
average.

Southwest Airlines Co. trades 22 percent below its historic valuation,
even though earnings at the Dallas-based company have surpassed
analyst projections for the past five quarters and are forecast to
rise 65 percent in 2013. The shares are up 4.3 percent in 2012.

Of the 500 companies in the index, 245 have price-earnings ratios
below their five-year means, data compiled by Bloomberg show. That’s
up from 196 at this time last year and 174 two years ago, the data
show.

Bull markets “normally finish with a real burst of hyper enthusiasm,”
Michael Shaoul, chairman of New York-based Marketfield Asset
Management, which oversees $3.5 billion, said in a phone interview.
“We haven’t seen the beginning of that yet. The transition from tepid
enthusiasm to hyper enthusiasm is going to be worth few hundred points
in the S&P.”

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