Chip sales continue to "roll on upward" - should be very good news for the semi-equip companies. As usual Gottfried, thanks for all the chart work you do. It really helps to see the data in "picture" form.
I am posting below an assessment of 2004 market performance by Briefing.com. We may want to review at the end of the year to see how close they came to the mark.;-)
<<Sizing Up 2004 - Looking Good, but not Like 2003
[Briefing.com - Dick Green] The stock market outlook for 2004 is reasonably good, though perhaps not quite as good as most of the press coverage suggests. There is certainly a lot of momentum heading into the new year, but the second half of the year may be problematic. This column looks at various assumptions for earnings growth, valuation, and interest rates, to assess possible outcomes.
Assessing Various Scenarios
The table below presents a range of possible 2004 factors for earnings growth, interest rates, an implied P/E on as-reported earnings, and a resulting end of year gain for the S&P 500. The individual columns are discussed and explained below.
First, the assumptions on earnings growth are quite strong. The range presented is from 10% to 15%. This is consistent with Wall Street expectations of about 12% for next year. Our view is that a strong gain is highly likely, given the momentum in the economy and continued productivity gains, and that this range is appropriate. This compares to what will be about 16% earnings growth for 2003.
Second, the assumption on interest rates is that rates will move higher. A move to a 4.00% yield on the 5-year note would correspond to maybe 50 to 75 points of tightening on the Fed Funds rate by the Fed and a yield of close to 6.0% on the 30-year note. It is not our expectations that rates will rise that much, but the data are presented to show the resulting impact.
Third, the P/E for the S&P 500 is calculated based on the 5-year note yield. There is a long-term historical correlation that the earnings yield on as-reported earnings for the S&P 500 runs about 120% of the earnings yield on the 5-year note. This is not a precise correlation by any means, but is a useful starting point as a benchmark. Thus, a 3.60% 5-year note would suggest a 4.32% earnings yield (E/P). The associated P/E for that yield is the inverse of 4.32%, which is 22 (100 / 4.32). (Note: use of the 10-year note yield long-term relationship implies a bit more upside for the market under all scenarios below).
Including likely fourth quarter earnings growth, the current as-reported P/E on the S&P 500 is about 23. That is reasonably consistent with the long-term relationship, and thus provides a good baseline for the following projections. In other words, using the 5-year note standard, the market is reasonably priced at present.
Earnings Growth 5-year note yield P/E % Gain for S&P 500
15% 3.34% 23 15%
15% 3.60% 22 10%
15% 4.00% 20 0%
12% 3.34% 23 12%
12% 3.60% 22 7%
12% 4.00% 20 -3%
10% 3.34% 23 10%
10% 3.60% 22 5%
10% 4.00% 20 -4%
To summarize - if interest rates stay unchanged, the current reasonable valuation of a P/E of 23 suggests that the S&P 500 in 2004 will rise in line with earnings growth. If earnings grow 12% in 2004, a good starting point would be to assume the S&P will also rise 12%
However, if interest rates start to rise in the middle of next year, then it is reasonable to expect the P/E to contract. Thus, a rise in interest rates might lead to a 5% to 10% contraction in the S&P 500 as the P/E multiple drops to 22 or 21, or even 20. In this case, the S&P 500 would rise at a rate consistent with earnings growth, less the impact of the contraction in the multiple.
Our best guess, if forced to make one, would be that earnings will grow 12%, and that the 5-year note yield will rise to about 3.60%. That would mean a slight contraction in the current P/E of 23 to 22, and produce a 7% gain for the S&P 500 in 2004 (as in the blue line row in the table). Because earnings are likely to grow at a faster rate in the first half of the year than the second, and because the backup in rates is more likely in the second half of the year, most of the gain for the S&P 500 could be in the first half of the year.
No Longer Out Front of the Bulls
Briefing.com has been flat out bullish since April of last year. We have consistently emphasized the strength of the economy in the face of mixed data. We have had no hesitation about stressing the fantastic earnings growth that corporations are putting up. And, we have been strident in our defense of valuation because of the impact of low interest rates.
Now, we are leaning a bit the other way.
There is no question that the fundamentals remains excellent. Economic growth will remain strong in 2004 and probably surprise on the upside. Earnings growth will be double digit. Yet, it seems that just about everywhere we look, the forecasts are for another 20% plus year for the market in 2004. In our view, the numbers just don't add up that way.
It could very easily be a solid 7% to 10% year for the market in 2004, but another 20% year would require earnings growth of 20%, or an expansion in the P/E multiple. A further expansion in the P/E would only be warranted if interest rates drop even further or if earnings growth accelerates sharply. Neither seems likely. Another year of 20% does not seem to be in the cards.
What it All Means
The stage is set for another up year for stocks, barring a significant upturn in interest rates. Earnings growth coupled with only modest increases in interest rates should lead to further gains in the indices. If earnings growth picks up without pushing interest rates higher, a great year is in store. But if interest rates start to rise by mid-year, and forecasts for earnings growth slow down at that time, the second half of the year could see the upward momentum in the market slow appreciably.
Long-term investors need to stay in this market. The first half of the year could be excellent for stocks, because earnings growth will be very strong, and interest rates are unlikely to move much. The Fed isn't about to raise interest rates. The second half of the year could be much more problematic, especially if expectations build that interest rates are going to start rising.
The key to 2004 is likely to be interest rates. If rates back up, the resulting contraction in the P/E will stop this market in its tracks. But if rates remain relatively stable, the near certain momentum in earnings growth will keep this market moving steadily forward.
Dick Green, Briefing.com dgreen@briefing.com.>> |
