Market Perspectives – September 2014

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Overview: This month we offer an update on corporate earnings growth and look below the surface. S&P 500 earnings advanced nicely during Q2 and sales growth was respectable. We view the low rate environment, while fragile, as a meaningful part of the equation in helping companies maximize profitability. Share repurchases are also approaching peak levels and aiding earnings growth. As we move into the latter part of 2014, we are keeping an eye on sales growth, which we believe is a necessary ingredient for higher equity prices going forward.

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• Q2 2014 earnings,

growth is 9.4%, with sales advancing 4.4%.

• This was at least in part

due to an economic rebound from weather related troubles of Q1.

• We are monitoring the durability of this improvement.

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An Earnings Update Post Q2 Results…

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• The current rate environment remains accommodative to equities, although the longer term sustainability of such low rates remains a question as the Federal Reserve seeks to end quantitative easing and potentially raise interest rates next year.

• International bond yields may remain very low (and central banks abroad may be increasing accommodative measures).

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Low Rates Support Growth and Valuations for Now…

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• Debt to EBITDA ratios have dropped from over 5x to under 1.4x over the past 10 years.

• Companies have been able to deleverage, thereby lowering borrowing costs and improving profitability.

• Capital structure improvements have created more flexibility amongst domestic large cap companies, allowing for an increase in stock repurchase plans.

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Leverage Ratios Have Dramatically Improved

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Stock Repurchases are Approaching Peak Levels

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• Stock repurchase activity is nearing previous cycle highs. The immediate payoff of this is in the form of higher earnings per share.

• According to Barclay’s

estimates, share repurchases have boosted earnings per share growth by ~ 1% for the median S&P 500 company. To provide some context, earnings growth was approximately 4.6% and 9.4% in the first two quarters of the year, respectively.

Source: Bloomberg.

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Quarterly S&P 500 Stock Repurchase Activity, Q1 2000-Q1 2014

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Slides of the Month – September 2014

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Conclusion: Sustainable sales growth will go a long way towards increasing valuations from current levels. In addition to operational efficiencies which have been actively discussed by the analyst community, certain financial factors such as low rates, improved balance sheets, and stock buybacks have in part acted to buoy earnings. While we expect a change in the low interest rate environment could slow some of the financially driven earnings growth, we are monitoring sales going forward, which will help determine the durability of the current market cycle.

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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 that we believe 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.

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Disclaimer

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