market perspective march 2015

Market Perspectives – March 2015

Experience Insight Impact

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Overview: With fourth quarter earnings season largely complete, it is timelyto reflect on corporate profits for 2014 and look forward to 2015. This monthwe look at the path of U.S. corporate earnings and explain the dynamics ofthe most widely used method of valuation, P/E, or Price divided by Earnings.

Monitoring Earnings


Back to the Basics

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• What is P/E? “P” is the price of security and “E” is the earnings stream over some period of time,typically a year. It is the cost an investor is willing to pay for a company’s earnings. When price isdivided by earnings, the result is a P/E multiple.

• The range of P/E multiples for individual companies vary greatly. A company’s P/E is mostlydetermined by its ability to grow its earnings over time. For example, a company who competes in avery mature and capital intensive business will typically trade at a lower multiple. Conversely, acompany with large market opportunities and low incremental costs to grow will tend to garner amuch higher multiple.

• When a stock price advances, either the P/E multiple rises, or the earnings grew. For example, if astock is trading at $100 per share, and the stock is earning $5 per share, then the P/E is 100 divided by5, or 20x. If the stock price moves to $150, either the earnings grew or the P/E multiple grew. Ifearnings grew from $5.00 to $7.50, then the stock would still possess a P/E multiple of 20x, or 150over 7.5. If the earnings did not grow and remained at $5 per share, and the stock grew to $150 thenthe P/E multiple would have expanded to 30x, or 150 over 5. In other words, the stock is moreexpensive because the market went from being willing to pay $20 for a dollar of earnings to $30 for adollar of earnings.


Where are Current P/E Multiples?

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• Examining the S&P 500companies together, thepicture gets clearer. Thetypical P/E multiple for theS&P 500 over timeaverages in the 17x range.

• This chart represents theworld’s major markets andcorresponding multiples.

• As you can see, the U.S. istrading just under 18x2015 consensus earningsestimates, a slightpremium to history.


Market Multiple

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• The S&P multiple is currently above the 60 year median P/E of 16.7x

• Wharton Professor and noted market observer Jeremy Siegel recently wrote about the key reasons:

• Higher multiples are justified in today’s ultra-low interest rate environment.

• 2015 earnings estimates have been slashed at a magnitude typically reflective of recessions dueto a stronger dollar, the collapse of energy prices, and the sharp rise in pension obligations.

• The next few slides examine market earnings or the “E” in more detail.


What Sort of Earnings Growth Have We Seen?

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With 4th quarter earnings reports almost complete, S&P500 earnings growth for the 4th quarter was just under 5%.

For the full year 2014, S&P earnings grew just over 6%.


What Does the Future Hold?

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The next several quarters (to the right of the thin, verticalline) show negative growth for the first time in manyquarters.

Full year 2015 consensus estimates show just 1.2% growth,which is substantially lower than we have seen the pastseveral years.


Why is this Important for Clients?

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• For markets to continue to advance, we must see multiple expansion and/or earnings growth.

• With interest rates and inflation low, we may see multiples continue to expand. That said, in recentyears we’ve seen multiples expand from the low double digits to the mid/high teens. In order formultiples to continue rising, it would likely take an acceleration in growth beyond current forecasts.

• The current consensus estimates suggest that earnings growth may be more challenging. S&P 500earnings are projected to grow just 1.2% in 2015. We are cautious on the forecasts in that they havebeen consistently wrong. However, the direction of change is cause for some level of concern.

• In light of the earnings projections, U.S. equities appear to be within the range of fair value on ahistorical basis. We remain nimble and are closely monitoring earnings, expectations and the variablesthat enter the equation in evaluating the current environment.

Market Perspectives – March 2015


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Conclusion: As suggested in the past, valuations and earnings are criticalto our process. Our goal in managing assets is to allocate capital wherevaluations look reasonable, while accounting for growth. We strive toremain flexible in our approach and revisit our investment thesis asconditions change.

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Opinions expressed in this commentary may change as conditions warrant and is for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources believed to be reliable, but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. Consider seeking advice from a professional before implementing any investing strategy.


Disclaimer

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market perspective march 2015

Economy & Finance