S&P 500 Cheapest to Bonds on Zero Fed Rates
Wednesday, 22 February 2012 | 00:00
The Standard & Poor’s 500 Index is approaching the cheapest level ever compared with bonds as Federal Reserve Chairman Ben S. Bernanke’s zero-percent interest rates drive investors and companies from cash.
Profits that doubled since 2009 pushed the index’s so- called earnings yield to 7.1 percent, close to the highest on record when compared with the 10-year Treasury rate, according to data compiled by Bloomberg since 1962. American companies have boosted capital spending 35 percent over six quarters, the most since 2006.
“Conditions are almost ideal for equity investors relative to all other investments,” Keith Wirtz, who oversees $14.6 billion as chief investment officer for Fifth Third Asset Management in Cincinnati, said in a Feb. 14 telephone interview. “The Fed’s keeping rates low for the foreseeable future to try to stimulate the environment for employee hiring and business activity. What does that mean for capital markets? Savers are not being rewarded.”
The U.S. government and the Fed lent, spent or guaranteed as much as $12.8 trillion to end the worst recession since the 1930s. That and Bernanke’s three-year effort to drive down interest rates are paying off with rising consumer confidence and expanding factory output. The S&P 500 (SPX) is off to its best annual start since 1997 as riskier assets lure money from savings accounts offering some of the lowest yields on record.
Individuals are responding with indifference amid the slowest economic recovery in at least six decades. New York Stock Exchange volume fell to the lowest level in 13 years last month. While unemployment slipped to 8.3 percent in January from 9 percent in September, joblessness remains more than two percentage points above its average level since 1990, according to data compiled by Bloomberg. Existing home sales reached an annual rate of 4.6 million in December, 23 percent below the average between 1999 and 2006.
The S&P 500 climbed 1.4 percent to 1,361.23 last week, within three points of a three-year high. Reports showed housing starts increased more than forecast and claims for U.S. jobless benefits slipped to a four-year low. Applied Materials Inc. (AMAT), the biggest maker of equipment for semiconductor plants, increased as much as 5.5 percent after saying sales this quarter may be 20 percent above analysts’ estimates.
Futures on the S&P 500 rose 0.3 percent to 1,364 at 8:26 a.m. in London today.
Investors who kept money as cash have missed out. A balance of $10,000 would have earned $184.60 in interest since December 2008, based on the average monthly savings rate compiled by Bankrate.com. For Treasuries, the return was $1,644. U.S. equities generated $5,690 including dividends.
Fed policy makers highlighted concern about the rate of capital spending when they pledged to keep interest rates low for at least two more years on Jan. 25. “Growth in business fixed investment has slowed,” they said, altering the last statement from “business fixed investment appears to be increasing less rapidly.” Factories in the U.S. boosted production 0.7 percent in January for the biggest back-to-back increases in more than two years, the Fed said Feb. 15.
“The real target for the low rates is indeed businesses,” John Canally, who helps oversee about $330 billion as an economist and investment strategist at LPL Financial Corp. in Boston, said in a Feb. 14 phone interview. “They want to push money out on the risk spectrum. They want that to be put to use buying a new piece of equipment or expanding a plant or adding a third assembly line.”
One of the Fed’s two mandates is restoring employment. Of the 8.8 million jobs lost in the U.S. due to the recession, about 3.2 million have been recovered, figures from the Labor Department show. On Feb. 7, Bernanke cited Labor Department data released Feb. 3 showing the share of working-age people in the labor force had declined to the lowest level in 29 years.
S&P 500 companies increased capital expenditures 35 percent from June 2010 through the end of 2011, the fastest rate since June 2006, when stocks were in the middle of a five-year bull market, data compiled by Bloomberg show.
Earnings in the S&P 500 have more than doubled to $96.58 since 2009 and are projected to reach a record $104.28 this year, more than 11,000 analyst estimates compiled by Bloomberg show. The earnings yield, or annual profits divided by price, climbed to 7.1 percent, 5.1 percentage points more than the rate on 10-year Treasuries. That’s wider than in 97 percent of months in 50 years of Bloomberg data.
The spread was last this wide in the four months before the S&P 500 reached a 12-year low in March 2009, data compiled by Bloomberg show. The benchmark gauge for American equities has increased 101 percent since then, including an 8.2 percent increase in 2012, the best start to a year since 1997.
Low valuations and signs of recovery have failed to lure individuals back to equities. Stocks are trading at a 14 percent discount to their average price-earnings ratio over the past five decades. The multiple has been stuck below the mean of 16.4 times earnings since May 2010, the longest stretch below the average since the 13 years beginning in 1973, data compiled by Bloomberg show.
U.S. gross domestic product expanded an average 2.4 percent a quarter in the 2 1/2 years since the recession ended in 2009, data compiled by Bloomberg show. The world’s largest economy hasn’t had a smaller post-recession recovery rate since at least the 1940s, the data show. In the 2003 bull market, GDP rose 2.7 percent on average, before the S&P 500 surged 102 percent. For the 1982 rally, the rate was 5.7 percent. Equities more than tripled in that cycle.
“The old story was that the steeper the recession, the stronger the bounce back,” Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, said in a Feb. 16 phone interview. The firm oversees $40 billion. “This is the worst recession since the Great Depression, and yet despite all that the Fed has done, despite huge stimulus from the federal government, the economy is just growing at this very sluggish 2 percent pace.”
Even as the S&P 500 doubled, investors pulled money from mutual funds that buy U.S. stocks for a fifth year in 2011, the longest streak in data going back to 1984, according to the Investment Company Institute in Washington. Withdrawals were $135 billion last year, the second-highest total after 2008. Net inflows have amounted to almost $1 billion in 2012.
Debt to Equity
Capital investments surged in 2006 as the total debt-to- assets ratio in the S&P 500 was climbing to 38.8 in the third quarter of 2007, the highest point since at least 1998, data compiled by Bloomberg show. The ratio is about 32 percent lower now. Companies spent the past three years paying down debt and cutting costs, boosting the S&P 500 profit margin to 13.8 percent, compared with 8.3 percent in 2009, the data show.
S&P 500 companies increased cash and equivalents for 12 straight quarters to $998.6 billion in the third quarter, 60 percent more than in September 2007, just before the index reached an all-time high of 1,565.15, according to S&P. The total excludes financial, utility and transportation companies.
Applied Materials’ second-quarter profit and sales forecast topped estimates on Feb. 16, signaling semiconductor makers are pulling out of a spending slump. Customers such as Samsung Electronics Co. and Taiwan Semiconductor Manufacturing Co. are stepping up spending, according to Patrick Ho, an analyst at Stifel Nicolaus & Co. in Dallas.
Walt Disney Co. (DIS) boosted capital investments by more than 10 percent each fiscal year since 2009, increasing them by 69 percent last year. The largest U.S. entertainment company by market value put the first of two new cruise ships into service last year and is expanding Disneyland Hong Kong, while designing a theme park in Shanghai.
The company also announced a $16 billion buyback plan in May. The stock trades at 15.7 times reported earnings, compared with the average of 26 in the five years before the financial crisis, Bloomberg data show.
Apple Inc. (AAPL), the world’s largest company by market capitalization, boosted its capital investments 60 percent each year, on average, since 2008, helping raise the return to 39 percent last year from 20 percent in 2006, according to data compiled by Bloomberg. The Cupertino, California-based company’s earnings are expanding so fast that even with a 24 percent rally this year, the stock is trading at less than half its average valuation since 1990, data compiled by Bloomberg show.
“Companies have a lot of cash, and it’s not prudent for investors to pay up for cash,” LPL’s Canally said. “Doing a little bit of capital spending has a pretty high multiplier effect on the economy, where cash on the balance sheet doesn’t have any. That’s what the Fed’s trying to drive at.”