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Post-Rally, Stocks Still Undervalued

John Blank

Just above 14 times this year’s earnings, stocks remain undervalued.

Consider our financial market landscape. Even after its recent rise, the 10-year U.S. Treasury pays a meager 2.00%. Your checking account and CDs offer even less. Historically, the earnings yield on stocks is +3% higher than the U.S. Treasury rate. Meaning stocks should offer investors a 5.00% likely annual return.

A stock’s earnings yield is nothing more than turning the P/E ratio on its head. When we divide a $105 projected earnings consensus for 2013 by an S&P 500 index around 1500, we get a 7.0% earnings yield.  After January’s rally, solid proof still exists on undervaluation.  

With all the above, we remain comfortable putting out a 2013 target of 1600 for the year-end S&P 500. That is only an earnings yield of 6.56%.  In fact, if we get towards the end of 2013 with U.S. GDP in healthy shape and no U.S. recession on the horizon, we could easily get a nice stretch above 1600.

Having said that, stocks ran too hot in January and early February. A short-term pause or correction is due.

Q4 Earnings Reports In

For Q4, 342 S&P 500 companies reported earnings and revenues by Feb. 8th.  They were up +2.8% and +0.9%, respectively. Revenue outperformance has been largely a function of subdued expectations. Composite (all 500 company) earnings and revenue growth rates for Q4 are +1.6% and +0.5%, respectively. Better than Q3, but the second lowest growth rates since recovery got underway in 2009.

The market doesn’t seem overly concerned.  It is looking ahead to expected GDP growth in 2H. Earnings growth in 2H-13 and 2014, which mirror estimates for GDP growth, shows a material ramp up.  A less worrisome tone of company guidance on Q4 earnings calls and recent favorable macro data raised confidence. This has been at play in the S&P 500’s positive momentum.

A Fresh Look at Zacks Ranked Industries

(A) With a rise in Jan. U.S. jobs numbers and upward 2012 jobs revisions, and an improved stock market, the personal side of Consumer Staples and Consumer Discretionary was highly ranked:  Personal Products, Home Furnishing Appliances, Apparel, Leisure Activities and Packaged Foods ranked well.

Consumer Electronics, Autos-Tires-Trucks and Tobacco industries showed us very weak Zacks Ranks in the consumer space.

(B) High Zacks Ranked industries arrived from building U.S. momentum in the Finance Sector focused on home finance and the stock market. Thrifts & Mortgage Finance and Investment Banking & Brokering industries showed up strong.  

Real Estate moved down to a Market Weight.

(C) Marked improvement in the global outlook (mostly China) pushed up Materials. Fresh strength was apparent in rising Zacks Industry Ranks for Chemicals, Paper, Steel and Fertilizers/Ag. Chemicals.  

(D) In addition, there is a notable change inside Industrial sectors on this stronger global outlook.  Airlines, Environmental Services and Construction & Engineering Services have rebounded.  

Industrial Services, Metal Fabricating and Industrial Machinery still struggle.

(E) IT recovered too, as Telco Hardware and Computer Hardware rose to become attractive Zacks Ranked Industries, while Semiconductors rose to a market weight. Computer Software & Services was ranked as a market-weight industry after the latest spate of earnings.

(F) Stronger oil and gasoline at the pump prices played out within the Energy sector.  We saw Refiners & Marketers and Pipelines do best, though there was a Zacks Rank rise in Drilling, E&P and Integrated Oil companies further downstream.

Alternative Energy and Coal remain weak, victims of low natural gas prices.

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