20 Aug Economic overview: July 2014
The FTSE/JSE All Share Index (Alsi) returned 23% per annum over the past three years and 30% over the past year. The major underlying sectors delivered similar returns over the past year while resources lagged over the three year term but caught up over the past 12 months.
The Rand was range bound over July, trading at between 10.78 and 10.51 to the US dollar. Analyst expectations were disappointed by economic indicators but company reporting in the US and Europe surprised them on the upside. The S&P 500 Index overshot analyst expectations by 1.57% on sales and 5.19% on earnings. The actual year on year sales growth for the second quarter was 4.41% and earnings growth was 9.56%.
THE BIG QUESTION IN THE MARKET IN THE MARKET IS, “IS THE CURRENT PE RATING OVERDONE?”
The S&P 500 Index is trading at a 12 month historical PE of 17.5 and 15.3 one year forward (the forward PE assumes earnings growth of 14.3% on a rolled 12 months). For the earnings growth to be achieved, either margins or sales need to increase (or both). US corporate profits (margin) are close to an all-time high, with the S&P 500 Index profit margin being close to 10%, leaving little room for improvement. Therefore, to reach the PE of 15.3, sales need to increase. 12 Month historical sales growth is currently at 5.1% year on year, this is close to US Nominal GDP and marginally below the long term average of 5.4% (1991 to date). Because consensus only expects sales to grow by about 5% in the third and fourth quarters, we need to question if the expected earnings growth will be achieved. Given this uncertainty, one would expect the market rating to be a bit more placid. However, our top down macro modelling indicates that earnings will follow the higher than expected US GDP levels and grow by around 15% in 12 months’ time.
Our opinion? We expect the market to hover at current levels until earnings play catch-up to allow for a more reasonable rating to realise.
Real GDP expectations (using IMF forecasts) are set out below: