In my previous article I suggested the S&P 500 could very well reach to 1875 in the near term. The monetary easing of the central banks is at the moment very beneficial for the stock market. However, for the longer term, indexes cannot hold on to these levels without the support of decent company earnings.
Now let's have a look at company earnings since the Lehman collapse. We all remember 2006 as the year when the economy was doing great and no one (maybe with the exception of Goldman Sachs) had ever heard of a housing bubble. But look at this table of S&P earnings. The second column is the P/E ratio and the last column is the earnings yield:
|2012 Actual GAAP Earnings||$86.46||16.5||6.1%|
|2011 Actual GAAP Earnings||$87.23||15.7||6.4%|
|2010 Actual GAAP Earnings||$76.97||16.3||6.1%|
|2009 Actual GAAP Earnings||$50.97||21.9||4.6%|
|2008 Actual GAAP Earnings||$14.88||60.7||1.6%|
|2007 Actual GAAP Earnings||$66.18||22.2||4.5%|
|2006 Actual GAAP Earnings||$81.51||17.4||5.7%|
|2005 Actual GAAP Earnings||$69.93||17.8||5.6%|
|2004 Actual GAAP Earnings||$58.55||20.7||4.8%|
|2003 Actual GAAP Earnings||$48.74||22.81||4.4%|
A huge decline in 2008 was followed by a spectacular increase already in 2009. In 2010, with banks still struggling, the 2006 level was almost equaled. The last couple of years companies have been very profitable. With an estimated $125 projected for 2014 the S&P 500 companies have doubled their profits in 10 years time. With a financial crisis in between that is quite an achievement. Earnings for 2013 have been estimated at $112 and for 2014 at $125.
The main reason companies have got back on track so fast is China. With the demand failure in the Western world in 2008 and 2009 the big corporations had already shifted their focus to emerging markets. The impressive growth numbers in China more than offset the losses in revenue back home. Meanwhile, companies were quickly adapting to the new economic reality. The workforce was reduced and cost control became very important in upholding the earnings level.
Let's not forget that without the crucial steps governments and central banks took back in 2008 things could have been really different right now.
The question is if corporations will be able to extend their profitability into the coming years. However, for the near term the corporate sector is in a very favorable position. The economy is growing (albeit slowly) and consumer demand is coming back. S&P 500 earnings could get another boost when bank earnings are returning to pre-crisis levels. It might be a little premature to say, but with company earnings growing at a 7% level in the coming years, there definitely is a lot more upside potential for the financial markets.