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Contrarians Note:
It’s Getting Awfully Consensus that Market Has Made Its Cycle Low
Consensus looks to be establishing the view that the equity rally from the March 9th
low is the start of a new bull market. A survey we took of our lunch guests yesterday
in Connecticut is the fifth investor survey over the last month to exhibit similar
sentiment to this point. While lack of institutional participation could help the market
melt higher from here, our contrarian instincts make us wary over the long-term
sustainability of this rally.
Strategas Institutional Has the S&P 500 made its final low at
Investor Survey 666.79 on March 6th, 2009?
Date Event Yes No
1 0x 1 0x
5x 5x
` '42 '45 '48 '51 '54 '57 '60 '61 '64 '67 '7 0 '7 3 '7 6 '7 9
1 5x 1 5x
1 0x 1 0x
5x 5x
'7 9 '83 '87 '91 '95 '99 '99 '02 '05 '08 '1 1 '1 4 '1 7 '20
Strategas Research Partners www.strategasrp.com 2
Don’t Buy the Headfake in Multiples,
Period of Secular Contraction Still in its Middle-Innings
In the post-World War II environment recession-related profit declines and recoveries
have been V-shaped in orientation – averaging 6 quarters from peak to trough and 6
quarters from trough to previous peak. The magnitude of decline has averaged -18%
from peak to trough, requiring a +36% increase in earnings to climb the “V.” This has
largely been possible due to two drivers: 1) productivity gains; and 2) financial leverage.
(We’ll leave the productivity argument aside for a moment. Our Chief Economist,
Don Rissmiller, has written about the long-term pressure on productivity gains.) On
the leverage front, companies that employ greater risk generally garner lower multiples.
To the extent they are replaced in the Index by companies employing less risk (and
garnering a higher P/E), the net effect is for aggregate multiples to increase – this along
with a absolute decline in “E” accounts for the sideways progression of valuations.
In this cycle, S&P profits peaked in 2Q ’07 – 8 quarters on, earnings are lower by nearly
-50%. We are of the view that earnings will decline through 3Q ’09, good for a 9
quarter retracement. In order for this profit cycle to “V” profits will need to double in
the ensuing 9 quarters. This could be tough to come by. Given that: 1) Financials now
represent a smaller portion of the Index (roughly 13%, down from 22% in ’06); 2) their
earnings power is impaired; and 3) their usage of leverage is curtailed (at least for the
moment), the recovery in Index profits will likely take far longer than many investors
would estimate – remember, it took over 4 years for earnings to increase +75% in the
late-’70s under similar macro conditions.
For trend watchers, we have broken the S&P 500 down into Industry Groups
benchmarking multiples at 5 and 1 year ago to today. For many groups, the sharp
contraction of earnings and the recent run in share prices have left things looking a little
expensive. The question to ask is, with the market rallying +35% in three months, will
investors continue to pay up for an uncertain profit picture.
S&P 500 Industry Group Forward P/E Relative S&P 500 P/E
5-Years 1-Year 10-Year
Present
Ago Ago Avg.
Diversified Financials 0.73 0.83 1.47 0.75
Materials 0.95 1.05 1.54 0.92
Banks 0.68 1.05 1.46 0.73
Energy 0.87 0.77 1.06 0.82
Retailing 1.08 1.04 1.28 1.08
Consumer Durables & Apparel 0.73 1.27 1.45 0.80
Real Estate 1.64 2.15 2.34 1.91
Commercial & Professional Svc. 1.08 0.94 0.93 0.99
Telecommunications Services 1.04 0.96 0.93 0.97
Consumer Services 1.15 1.14 1.06 1.04
Capital Goods 1.05 0.97 0.90 0.96
Technology Hardware & Equipment 1.36 1.17 1.06 1.40
Pharmaceuticals Biotech & Life Scn. 1.06 0.89 0.75 1.06
Food & Staples Retailing 1.24 1.10 0.91 1.03
Transportation 1.18 1.22 1.01 1.03
Household & Personal Products 1.27 1.17 0.96 1.13
Food Beverage & Tobacco 0.96 1.13 0.92 0.95
Software & Services 1.32 1.20 0.97 1.40
Insurance 0.71 0.66 0.53 0.69
Media 1.48 1.03 0.80 1.55
Health Care Equipment & Services 1.10 1.00 0.77 1.04
Utilities 0.79 1.07 0.76 0.80
S&P 500 -- -- -- --
2009 2010
Sales $100.00 $103.00 3.00% Revenue Gain*
(Costs) $95.90 $97.82 2.00% Cost Increase
Income $4.10 $5.18 26.3% Earnings Gain
Margin 4.1% 5.0%
A 26% increase off our 2009 estimate of $51.75 *Strategas 2010 nominal GDP forecast, 3.0%
would imply earnings of roughly $65 in 2010. We
are currently forecasting $59.25 for 2010.
350
300
Upside
Golden Cross
250
12.0%
1 0%
4.2%
0%
-2.6%
-4.3% -4.6% -4.6%
-1 0% -7.6%
-2 0% -17.7%
-22.1%
-3 0%
'9 8 '9 9 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09