Growth Prospects Dimming in Equities

By Peter Pham - May 9, 2012 | Tickers: AAPL, GOOG, SPY | 0 Comments

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While earnings season for the first quarter is nearly over and a number of big names reporting stellar results, such as Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG), the truth is that the S&P 500 (NYSEMKT: SPY) is still trading at a very steep multiple to trailing earnings.  As of Friday May 4^th, where the index dropped 1.62%, the S&P 500 was trading at a multiple of 22.83. 

Google and Apple alone represent 5.84% of the S&P 500’s market cap of $12.37 trillion. Their earnings represent 7.22% of the total for the index.  Looking at the top 10 stocks by market cap we find that they represent 21.5% of the total market cap of the S&P but only 11.5% of earnings.  In other words the top 10 stocks by market cap in the U.S. are being priced at 42.5 times their combined earnings.  Stripping out Google and Apple and the number soars to 122.5 times earnings.  [N.B. Wal-Mart had not reported earnings by the time of this writing and the number used was the current EPS estimate for them.]  I think it’s safe to say that the stunning growth of a handful of companies has suppressed the effective P/E of the index and is not indicative of broad based strength. 

Looking forward, Apple has guided for lower earnings growth and with the market trading at a premium multiple right now how can one justify it going forward as both Europe and the U.S. continue to muddle along and major economic indicators, however they may be massaged, continue to disappoint.

This is one of the reasons why the Non-Farm Payroll miss was such a shock to the markets.  The headline unemployment number is for the news media to spin.  The internals of the report were awful:

1. A massive birth/death adjustment of +206,000 jobs
2. A Labor Force Participation Rate of 64.3% the lowest level since 1982
3. 522,000 people left the workforce in April

Most of the companies that have seen excellent growth, like Apple and Google, have seen their revenues rise from overseas.  While China has likely gone through the worst of its hard landing they are also setting up for a slower overall growth path.   

Lastly, the question on everyone’s mind is when/if the Federal Reserve will begin QE3.  Looking at the monetary statistics, the Fed has been holding the monetary base flat for months.  This has put a negative bias on Federal Reserve credit which peaked in February and has been falling ever since.  To offset this, bank credit has been expanding which tracks with the fall in excess reserves held with the Fed.  In effect all of that money that the Fed stuffed onto their balance sheets after Lehman collapsed is now being lent.  M1, M2 and MZM, which have not stopped rising continue, just the source of funding is changing.  As a result of all of this the M1 multiplier has finally begun to rise consistently. 

These trends are healthier than they’ve been at any time since the Lehman collapse in 2008 and it seems that Ben Bernanke is employing his sterilization strategy at the present time; contracting Fed credit to allow the banks to resume their proper lending function.  The problem is that the economy in the U.S. is not responding.  So while the growth in Asia will offset the losses in the U.S. for some companies, like Apple and Google, the overall effect on the S&P will be muted for most of the rest of the stocks who rely on the American economy to survive capping any potential advancement.  If the Fed green lights another round of QE, brought about by a collapse of a European country like Spain or Italy, then the S&P will rally on the liquidity flows alone, but so will commodities and gold, which should yield a far better return.

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