Market Update March 2013

Market updates from JP Morgan & Envestnet PMC

Here are some thoughts (below) from pages 7 & 8 of the most recent JP Morgan Market Bulletin.  For more insights, go to their Market Insights website for good current information.  The Envestnet summary also provides good weekly insights.  Weekly updates can be found by clicking here

“Earnings hand the baton to multiples:

Despite the recent rally, equity valuations remain below their historic averages as seen in Table D (of the attached JP Morgan Market Bulletin from 3-14), which in our view, leaves room for multiple expansion going forward. Nearly every valuation metric in the table still appears lower than its 10 and 15 year average, suggesting there’s still some room to run before we need to concern ourselves with stocks beingtoo expensive. In addition, as highlighted in Chart L, earnings growth has been the sole driver of the post-recession rally, with sentiment-based multiple expansion only contributing during the last two quarters.  In other words, the multiple expansion-led bull market has only just begun. Historically speaking, once earnings growth stabilizes in the single-digit range, we see multiples expanding on average by 4% per year (Chart M). This is significantly more than the -2% average contraction in multiples that has been experienced during robust, albeit unsustainable, double-digit earnings growth. To be clear, by no means do we expect the outsized, +100% market returns that investors have experienced over the past four years to repeat themselves. These returns were driven by a substantial market displacement in 2008, and fortunately, equities have now finally recovered the lost ground. However, as seen in Chart N, an improvement in consumer sentiment to pre-crisis levels in light of less macro uncertainty should help multiples expand. Coupled with stable dividend yields and sustainable earnings growth, these forces should provide mid to high single-digit annual returns, outpacing the traditional alternatives of bonds and cash.

Investment Implications:

–          Despite weak headline numbers, fourth quarter EPS may have been stronger than reported given accounting methods for pensions. Controlling for these changes, fourth quarter growth remained consistent with a moderately healing U.S. economy.

–          Going forward, earnings estimates are clearly too high. While these estimates should fall as the respective quarter approaches, we do not expect markets to be materially affected.

–          Companies remain the leanest they have been in decades, leaving very little room for additional cost cutting and placing the burden of future earnings growth on stronger revenues.

–          As equities surpass their previous peaks and approach historical average valuations, this is not necessarily indicative of negative returns going forward. The removal of macro uncertainty combined with low, albeit sustainable, earnings growth should result in moderate equity market performance for long-term investors.”