Earnings for S&P 500 companies have been coming in better than expected with only a few high-profile exceptions (IBM, for one). Revenues have been a different matter. The recession in Europe is taking a toll on many companies, GE among them.
Over the long term, earnings determine stock prices. However, over a year or two they aren’t critical. For example, last year S&P earnings were flat, but stocks rose 13 percent.
Why was that? The attractiveness of stocks with dividends and dividend growth trumped all else and buyers were relentless. A year later and nothing has changed. Better-yielding stocks are still in demand.
Earnings growth in a slow-growing or stagnant economy becomes increasingly difficult, as we are seeing now. Cost cutting can go only so far and without inflation companies cannot put through price increases. That doesn’t mean stocks will fall. They won’t as long as interest rates stay low.
Rates should continue to remain low, but the market is offering warning signs for those that feel safe holding bond funds. The iShares 20+ Year Treasury (TLT) has lost 4.3 percent so far in May.
This is a hint of what will come when the trend turns toward higher interest rates. Although I’m early, I’ve already positioned client portfolio for higher interest rates by using adjustable rate securities and dividend paying stocks.
High yielding stocks remain in the sweet spot as investors seek yield. That’s why utilities trade for p-e multiples that are high for slow-growing companies. Some sell for more than 20 times earnings.
Never mind, at least for now. A need for income has pushed them higher and I don’t see that changing anytime soon. Still, expect brief bouts of profit-taking, as we are seeing now with investors moving into growth stocks.
Overall, there are many reasons stocks will work their way higher, likely much higher than most expect, especially those naysayers who have missed the rally. At the top of the list is still an easy one to understand — there is no alternative.
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.