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With five trading days left in Q1, it looks like the S&P 500 (NYSEARCA:SPY) will finish the quarter with its highest valuation in three years. At its current price, the S&P 500 has an LTM P/E of 16.1x. After gaining 9.2% year-to-date and growing its multiple, the S&P 500 will enter earnings season with high expectations. However, the current multiple is still low by long-term standards, so good earnings could sustain the rally. In this article, I will put the S&P 500's P/E multiple in historical perspective and look at the forward P/E multiples for the top 100 companies in the SPY. With the Federal Reserve plowing ahead with quantitative easing and Europe muddling though, Q1 earnings will likely be the catalyst for the S&P 500's next move.

S&P 500

The following is an annotated stock chart of the S&P 500 showing the key events of recent years and marking the start of each quarter's earnings season (represented by Alcoa's earnings). I also boxed Q1 2013 and Q1 2012 to show the parallels.

(click to enlarge)

(Source: FreeStockCharts.com)

S&P 500 LTM P/E of 16.1x

Since September 2011, the LTM P/E multiple for the S&P 500 has been rising (as measured at quarter end). Furthermore, the S&P 500 has not ended a quarter with an LTM P/E over 16x since early 2010 when it was still working off the effects of the 2008/2009 financial crisis.

(click to enlarge)

(Source: Standard & Poor's)

Over the long term, the current multiple does not seem high. The real issue is the market's ability to support a higher multiple in an era of slow global growth, fiscal austerity and extraordinary monetary policy. One could argue that the Fed's quantitative easing and the "whatever it takes" approach of the European Central Bank and the Bank of Japan should move investors into risk assets like equities and drive up the multiple. However, at some point earnings will need to confirm the multiple expansion.

(The earnings used for these graphs are the actual EPS figures for the prior 12 month period, meaning for a quarter ended on September 30, the data is based on the earnings for the previous July to June period. There are a number of ways to look at the S&P 500's P/E and they all show the same general trend).

Forward P/E For The S&P 500

Some say that there is no stock market, just a market of stocks. I like to take that approach when looking at the S&P 500. Instead of speaking about an abstract index, I prefer to look at what is happening with the top 100 stocks in the S&P 500 (or, for the sake of this analysis, the SPY ETF). Currently, the top 100 stocks in the SPY account for 64.3% of the value. The smallest of the 100 represents 0.23% of the SPY. Clearly, the other 400 stocks carry little weight on an individual basis.

For the current fiscal year, the mean and median forward P/E multiples of the Top 100 are 15.3x and 15.2x. The following table shows the forward multiples for the current and next fiscal years as well as the weighting of each company in the SPY. In the following sections, I will analyze these numbers in more detail.

(click to enlarge)

(Source: Yahoo Finance, see further notes below)

FY1 P/E Multiple Expansion/Contraction Over The Last 90 Days

It is not surprising that almost all of the companies in the Top 100 of the SPY experienced multiple expansion over the last 90 days considering the strong rally in the market.

However, it is interesting to see which companies have lagged or led.

The three main laggards are all technology companies: Apple (NASDAQ:AAPL), Oracle (NYSE:ORCL) and EMC (NYSE:EMC).

Apple's multiple contracted as investor sentiment changed dramatically over the last few months driving down the stock price. On the last earnings call, Apple disappointed investors and brought down future expectations. Analysts have downgraded the stock and lowered their price targets. I am actually bullish on Apple in the mid $400s as I wrote about here.

Oracle only became a laggard last week when it announced disappointing earnings. I was bullish on Oracle before earnings (here) and continue to view the stock favorably after the big price drop.

Finally, EMC's earnings also disappointed and weighed on the stock. EMC owns ~80% of VMware (NYSE:VMW) and VMW comprises a meaningful portion of its value. During the quarter, EMC and VMware hosted an analyst day that was well received by the market. I wrote about the positive impact of the analyst day here.

In general, technology has underperformed lately. Slow global growth, constrained government budgets and hesitant CEOs are headwinds for the tech sector. Several companies have also faced company-specific issues. With the market's multiple expanding and the S&P 500 approaching record highs, the technology sector and cyclical companies are very important in Q1 earnings season to see if further gains can be achieved.

It is also worth noting that the companies that experienced the most multiple expansion are all healthcare companies: Gilead (NASDAQ:GILD), Bristol Myers Squibb (NYSE:BMY), Celgene (NASDAQ:CELG), Biogen (NASDAQ:BIIB) and Allergan (NYSE:AGN). The healthcare sector has been a clear leader for the market in Q1.

(click to enlarge)

(Source: Yahoo Finance, see further notes below)

Which Companies Have a P/E Multiple Above/Below The Median?

The next chart shows the FY1 P/E multiple for each company compared to the median multiple of the group. If the bar is on the left of the Y-axis, that company has a multiple below the median. Bars on the right mean that the multiple is greater than the median.

Again, on the laggards side there are a lot of big/old technology companies, energy companies and financials. On the leaders side there are a lot of healthcare and consumer companies. Aside from financials, which have already had a big run, I am looking for signs of a rotation in market leadership away from the defensive sectors to the cyclical/growth sectors. The defensive sectors may not need to drop in price or multiple, but the laggards would need to perform better. I am not sure when, or if this will happen, but it doesn't seem like we cannot expect much more growth or multiple expansion from the defensive sectors.

(click to enlarge)

(Source: Yahoo Finance, see further notes below)

Conclusions

The S&P 500 is entering Q1 earnings season with the highest multiple in years. However, on a longer-term time frame, the current multiple is reasonable. I am looking for Q1 earnings season to be the catalyst for the next big move in the equity markets, since Europe and the Federal Reserve seem to have taken a back seat for the moment (but they will be back eventually). Looking under the surface at the top 100 companies in the SPY, it is clear that the technology sector is lagging. The technology sector may be an important "tell" for the market in Q1 earnings season.

Notes

The tables exclude the following: P/E multiples greater than 100 and P/E less Median values greater than 50. Additionally, some information about Amazon, Berkshire Hathaway, AbbVie and Abbott Laboratories was not available.

The mean and median figures presented in this article represent the unweighted mean and median of the metrics for the 100 components in the SPDR S&P 500 ETF Trust and are not capitalization-weighted like the index itself.

Earnings Estimates are based on data from Yahoo Finance as of March 24, 2013.

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Source: S&P 500's P/E Multiple Ending Q1 At 3-Year High

Additional disclosure: I may trade and of the stocks/ETF mentioned in this article at any time, including in the next 72 hours.