Breakout

High Hopes, High Prices and Reasonable Valuations Seen for 2nd Half

Breakout

Lately, it's rare that a day goes by, it seems, without the benchmark stock indexes setting fresh all-time highs. And while this lofty perch certainly feels scary to most investors, the earnings multiples that this six-month rally has been built upon remain modest and well below previous peaks.

In fact, despite weak earnings guidance for the second quarter (where 79% of the forecasts given were negative or below expectations), FactSet's senior earnings analyst John Butters says if you use full-year price-to-earnings ratios, equities are still relatively cheap.

"I think you can look at it two ways," Butters says in the attached video. "If you're on the bullish side, PE ratios are nowhere near record levels, but if you're more bearish, you can say we are now above the trailing five- and 10-year averages."

Specifically, he says the PE for the S&P 500 is currently at 14.3 times estimated full-year earnings, compared to its five- and 10-year averages of 12.9 and 14, respectively, and peak PEs of 19 or 20 times earnings at the height of the dot-com bubble in the late 1990s and early 2000s.

If stocks are to continue their recent uptrend and meet full-year growth expectations, the market (and the economy) are going to have to pick up the pace dramatically or risk delivering a huge disappointment.

Related: Weak Sales Growth Clouds Solid Q1 Earnings Season

As Butters explains, compared to the first few months of the year, analysts and investors have some pretty high hopes for growth. "Analysts are expecting a pretty significant rebound in earnings growth for the second half of the year," he says. "For Q3, they're looking for 8% growth, and for Q4 that jumps up to 13.5%."

This, of course, compared to 3.2% profit growth in the first quarter and expectations for just 1.7% increase in earnings for the second quarter.

While he says the second half numbers have come down a bit, "overall, analysts are still looking for a much stronger second half of 2013 than what we've seen so far for 2013."

Part of this anticipated uptick, he says, is based upon the belief that emerging markets (EEM) will lead improvement in the global economy, which is reflected in the rising hopes for the Materials sector (XLB). At the same time, Butters points out that an expectation of continued recovery in the housing market will be critical for the Financials (XLF).

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