As Sam Sees It: Long-Term Valuations Are Attractive Despite Europe's Uncertainty

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

EQ: About 20 percent of the S&P 500 companies have reported earnings so far, with about 58 percent beating expectations, 30 percent missing and 12 percent matching, according to Thomson Reuters data. Given that the bar was set so low already with expectations, are these results encouraging or unsettling for investors?

Stovall: Based on those numbers, I would say it is not encouraging. But the overall trend has been encouraging since we hit a low-water mark just a few weeks ago. Also, because investors thought that the bar was set so low entering into the earnings reporting season, that it could really only get better from here.

Plus, if you look to the market's performance thus far in the new year, if it were unsettling, I don't think we'd be in positive territory. As of Jan. 25, 2012, S&P Capital IQ projects Q4 2011 EPS for the S&P 500 to be up 7.2 percent. That is up from the 6.9 percent from Tuesday, which already included the Apple (AAPL) results. So Apple made a big splash in the earnings and as a result, based on the stock market performance, it appears as if investors are feeling encouraged by the numbers they're seeing.

EQ: By many valuation metrics, stocks could be called cheap right now as compared to where they are historically. But with the uncertainty hanging over the market and economy, do you have any advice for investors when evaluating their portfolio?

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Stovall: First off, let's see if you are correct on how cheap stocks actually are. When you go back to 1988, which is when Wall Street started looking at operating results, the median P/E has been 18. Right now, we're trading at 13.4x trailing 12-month results, which is a 26-percent discount to the median over the last 24 years. If you look to 2012, the P/E is 12.4, and for 2013 it is 11.0. So in my opinion, valuations do look fairly attractive. However, some investors would rather look at GAAP (Generally Accepted Accounting Principals) earnings. On that basis, we are trading at 14.7x trailing results, and that is a 32-percent discount to the median GAAP P/E since 1988. And if you look back further to 1936, when the average was a shade below 16, we are trading at a 7-percent discount.

So whether you look at operating results, GAAP results (also called as-reported-results), valuations do look relatively attractive, in our opinion. I do agree that the uncertainty regarding Europe is a definite overhang, but if you are a long-term oriented investor, share prices today do represent a good long-term value.

EQ: The Federal Reserve said that it plans to keep rates close to zero until at least 2014, extending from the previous target of mid-2013. Was the move already expected on Wall Street? What implications does it have on the market?

Stovall: I don't think it was fully expected by Wall Street because the S&P 500 jumped a couple of points once the statement was made. Any time that you have a lot of liquidity sloshing around, that usually pushes share prices higher because it allows for P/E expansion instead of contraction. So in general, it's positive for the market but obviously if things change between now and late 2014, I think the Fed would change their interest rate policy. Right now, however, based on what they know, they anticipate that they will not make a change to interest rates until late-2014.

I would go one step further and say that because the inflation rate is above their implied target of 2.0 percent on a core CPI basis, they probably would be less likely to engage in a third round of quantitative easing, maybe because they are doing so with very low interest rates, but also because inflation is above where they'd feel comfortable having it go. I don't think they want to further fan the flames of inflation.

EQ: What are some groups that could benefit from a prolonged low rate?

Stovall: Certainly, the benefit is the cyclical sectors. In general, they tend to outperform the defensive sectors. So companies found in Technology, Industrials, Materials and certainly Financials will benefit because as interest rates stay low, they can make money on the margin. They don't have to pay you anything for your deposits, but they're going to charge you an awful lot on the credit cards, and on a relative basis, the mortgages as well. So Financials and companies that are big borrowers of debt will benefit directly. In addition, cyclical sectors that are positively impacted from an expanding economy will benefit indirectly.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

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