Monday, May 2, 2011
According to Bloomberg's data on trailing earnings per share ($88.15 as of April '11), corporate profits have risen at a 20.9% annualized rate over the past six months, and 27% over the past 12 months. As the chart above shows, corporate profits by this measure continue to track the growth of corporate profits as measured in the National Income and Product Accounts, with the latter tending to be a leading indicator of the former.
Despite the impressive growth in profits, which show no sign yet of turning down, the market has been assigning a PE ratio of just over 15 to after-tax earnings for the first four months of the year. The current PE ratio is below the average (16.6) of the past 55 years, which is a sign that, at the very least, the market is conservatively priced. However, given that risk-free Treasury yields are very low from an historical perspective (giving today's 10-yr Treasury yield of 3.3% a PE ratio of 30), today's below-average PE ratios could be taken as a sign of substantial caution regarding the outlook for corporate profits.
This caution is confirmed by this next chart, which compares the earnings yield on stocks (currently 6.5%) to the yield on BAA corporate bonds (currently 5.9%). Equity owners normally should be willing to accept a lower yield than bond owners, since they can benefit from higher equity prices and higher top-line growth. Yet earnings yields have exceeded corporate bond yields for the past 12 months: a rare event, and a sign that the market believes that the outlook for earnings is very uncertain.
Full disclosure: I am long equities of all sorts at the time of this writing.
Posted by Scott Grannis at 11:32 AM