IB Net Payout Yields Model

S&P 500 Forward Earnings - $110

Even with tall the downbeat economic forecasts, S&P 500 earnings expectations for the next 12 months remains around $110. At a average PE multiple of 15, the S&P 500 would be trading at 1,650. The low interest rates and inflation would normally suggest a higher PE in the 16-17 range. That might sound crazy, but that is the reality if normality returns to the stock market.

The current bond markets and interest rates remind me of the real estate market around the end of 2006. Everybody thought housing prices in California and Las Vegas were extremely high yet most people kept piling on. The logic didn't make sense, but the end of momentum can be difficult to predict.

Fast forward 6 years and now the bond market is doing the exact same thing. Investors are jumping into bonds even though conventional wisdom suggests the opposite to be the best move. Stocks are very cheap on historical standards and earnings remain very strong yet few people want them.

Investors fear another recession or stock market collapse though those just don't happen unless the FED tightens monetary policy via higher interest rates. The absolute opposite is the case now. The FED is doing everything to encourage investors into risky assets such as growth stocks. Instead, the only investors willing to buy stocks are those with dividends. Again pushing people into the exact asset class that now has the potential of limited upside and possibly years of losses.

The below chart from the Yardeni blog shows the annual earnings forecasts for the past 18 years. Interesting to note that the 2013 estimates finally exceed the original numbers for 2009. So while corporate profits are strong, the level is just getting back to the original expectations for four years ago. The stock market though hasn't recovered to those record levels even though the actual earnings are hitting records.

Investors appear looking in the wrong direction as usual. The European crisis while significant has the possibility of being closer to the end than the beginning.  Investors again are looking in the rear view mirror for guidance.

Earnings are likely to keep surprising as long as investors keep doubting them. The media is likely to hype this earnings season as the most important ever, but just remember that solid US companies will continue growing earnings higher and higher no matter what the economic situation.

Disclosure: No positions mentioend. Please review the disclaimer page for more details. 


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