Earnings tend to rebound sharply during the start of bull markets and to grow less rapidly as the bull ages. Based on the performance of forward earnings over the past year, this bull market is ageing. After all, it will be 3½ years old next month.
While I’ll be happy if my yearend S&P 500 target of 1450 is surpassed in coming months, it’s getting harder to see much more near-term upside for the S&P 500 unless there is more upside in the forward P/E, especially since forward earnings is likely to remain relatively flat over the rest of the year. Let’s review the latest data more closely:
(1) Revenue growth is slowing. S&P 500 revenues are highly correlated with manufacturing and trade sales in the US. During June, these sales grew just 3.0% y/y, the slowest pace since November 2009. S&P 500 revenues edged up 0.3% q/q during Q2 and were only 1.9% above last year, the slowest pace since Q3-2009.
Industry analysts are lowering their expectations for revenue growth this year and next year. In mid-August, they expected S&P 500 revenues to increase 2.7% this year and 4.1% next year.
(2) Earnings are expected to grow faster than revenues. In mid-August, industry analysts expected S&P 500 earnings to rise 5.7% this year to $103.39 and 11.7% next year to $115.46.
(3) Profit margins are expected to increase. The only way earnings can grow faster than revenues is if the profit margin rises. Sure enough, industry analysts expect it will do just that for the S&P 500, rising from 9.3% in 2011 to 9.5% in 2012 and 10.1% in 2013.
Photo: Ed yardeni
I’m not as sure that margins will increase this year and next year. Another characteristic of an ageing bull market is a peak in the profit margin. When margins peak, earnings growth tends to slow down to about the pace of revenue growth, which also tends to slow down in an ageing bull market.
Photo: Ed Yardeni
Today’s Morning Briefing: Relief Rallies. (1) Stress testing the bull. (2) The never-ending endgame. (3) One bull market with four rallies. (4) Policymakers still ready, willing, and able to avert calamity. (5) The ageing bull is almost 3½ years old. (6) Running out of steam to charge ahead? (7) NERI was very weak in August. (8) Global economy is slowing, as Europe is on the edge again. (More for subscribers.)