By Carlos Guillen
Equity markets are ending the trading week with a bang, with the Dow Jones Industrial Average up over 130 points and testing the 14,000 level, something not seen since September 2007, as the economic data presented today motivated investors into stock investments.
Quite encouraging today was that consumer sentiment not only landed higher than expected, but it also reversed its negative direction. The University of Michigan's Consumer Sentiment January final result landed at 73.8, which was higher than the Street's expectation of 71.4 and higher than the preliminary level of 71.3, increasing from the 72.9 reached in December. Another encouraging aspect of the result was that it countered data from the Conference Board posted this past Tuesday that showed that consumer confidence fell for a second consecutive month. According to the Conference Board, its consumer confidence index fell to 58.6 in January from 66.7 in the prior month, landing well below the Street's consensus estimate of 65.1. Putting the icing on the cake, the index of expectations six months from now, which more closely projects the direction of consumer spending, rose to 66.6 in January from 63.8 the month before.
Another important fundamental bit of economic data out today was the Institute for Supply Management (ISM) Purchasing Managers' index (PMI), considered by many to be a very important health indicator of the manufacturing industry here at home. PMI in January clocked in at a rather encouraging 53.1 percent, landing above the 50.5 percent consensus estimate and increasing from the 50.2 percent reported for the prior month. Given that a reading above 50 percent indicates the manufacturing economy is generally expanding, this PMI result puts us into the second month of growth mode. Moreover, given that a PMI over 42.6 percent, over a period of time, generally indicates overall economic expansion, the result also indicates the 44th consecutive month of overall economy growth. In addition, new orders in the ISM report, considered to be an important leading indicator, also showed an improvement. In fact, new orders in January jumped back into growth territory landing at 53.3, up from 49.7 in the prior month.
Perhaps discouraging today was that the unemployment rate climbed, worse than expected. The unemployment rate in January was 7.9 percent, higher than the 7.8 percent reported for December and above the Street's consensus estimate of 7.7 percent. In addition, non-farm payroll employment increased during the month by 157,000, worse than economists' average forecast calling for a 180,000 increase. What was very encouraging, however, was that November's numbers rose from the originally reported 161,000 to 247,000, while December was pushed upward to 196,000 from 155,000. So, the reality was that there were more jobs added in the last three months than expected, and this was well received by markets.
In all, it is clear that investors have been motivated by the economic data presented today, and this has resulted in a sharp climb in the Dow, which has not shown any signs of retreat ... for now at least.
Market Breaks Milestone, Do We Deserve It?
By David Urani
Break out the bubbly, the Dow just touched 14,000 which for many is a milestone and an indicator of how far we've come since 2009 when we touched below 7,000. A lot of you may be saying that, considering employment (still at 7.9%) and GDP (4Q fell to -0.1%) the US economy is far from past glory and not deserving of being this close to the all-time highs. It's an understandable viewpoint, so it's worth delving into how the Street is valuing the market right now.
First off, I prefer to look at the S&P 500 than the Dow, which at 1512 is still 4% below the all-time high (the Dow is just over 1% away). Standard & Poors is kind enough to give us a running total of reported earnings for the whole index and consensus forecasts for earnings over the next year via their website, along with price-to-earnings (NYSE:PE) ratios so let's take a look.
When the markets last hit these levels back in 4Q 2007, the S&P traded at a trailing PE of 17.8. That was actually just below the 18.8 average PE since 1988. If you ask me, when you take into account the tech and housing bubbles, maybe a "normal" level should be considered as somewhere below 18.8, perhaps in the mid-teens.
Now turning to current valuation, PE is standing at 15.4 on a trailing four-quarter basis and at 13.4 on a forward four-quarter basis (expected 2013 earnings). So, compared to 2007 you could actually say the market is trading at a discount. Total S&P 500 operating earnings themselves are on pace to hit $23.83 for 4Q12 whereas they stood at just $15.2 in 4Q07 (in fairness though, the market was probably basing prices more on 3Q07 levels of $20.87). So corporate earnings are actually higher now than they were then, and are expected to go well into new all-time highs at $29.63 by 4Q13.
Of course, stock prices account for not only earnings but expected growth as well, and it's fair that the market would be discounting stocks based on lukewarm economic trends. Back in 3Q07 the economy was running at a 3.0% pace of GDP, although it fell to 1.7% in 4Q07. As we saw earlier this week 4Q12 GDP was -0.1% (considering it was largely due to a cut in defense spending there's a popular opinion that the result was better than it looked) , while economists are forecasting for 2013 to trend somewhere around 2%.
So then, considering past performance you could actually make a case that the current valuation of the S&P 500 is fair. Total earnings are close to all time highs (the record was 2Q12 at $25.43), and are expected to grow by 24% this year. Thus it would make sense that the S&P 500 index itself would be near record highs as well. Yet, considering there are still speed bumps in the economy one would be prudent to discount its value a little bit based on growth expectations, and the market still is.