Despite a worrisome development in France, one with negative implications for the survival of the Euro, U.S. stocks not only managed to rally Tuesday, April 24th and a couple of our core client holdings achieved new all time price highs. How to explain this? An analytical service to which we subscribe, “Chart of the Day” (www.chartoftheday.com) suggests that with the “corporate earnings yield” above 4%, and over 70% of S&P 500 companies reporting positive earnings surprises, we can expect further appreciation for the market over the remainder of the year. This, of course, does not preclude the possibility of a strong correction along the way.
The corporate earnings yield is essentially the ratio of a corporations earnings to its stock price. If a company is on track to earn $.40 a share and the share price is currently $10.00 this would represent a 4% corporate earnings yield. It is essentially a variation of the dividend yield, but considers that many corporations retain most of their earnings rather than paying dividends.
According to Chart of the Day’s analysts, going back half a century, when the corporate earnings yield is between 4% and 5% the market has risen about 6% over the next 12 months. If this were to come to pass, it would represent a nice, but not spectacular appreciation from current market levels and take the Dow to near the all time high seen in October 2007 around 14,000. Such an appreciation is, in my opinion, sustainable and therefore, credible.
Meanwhile, as mentioned, two of our core holdings touched new all time highs today, and those not shining so brightly are showing nothing other than normal corrective behavior.
I remain optimistic about stocks, but there are is one major ominous development that has me concerned: the French presidential election.
Nicolas Sarkozy, a strong supporter of a financially responsible European Union is fighting for his political life, having failed to gain a commanding lead in last weekend’s first round of voting, the one that winnows out fringe candidate and gets it down to just two. His Socialist Opponent Francois Holland favors higher taxes on the rich and intends to unwind some minor reforms to France’s welfare state. If France goes Socialist, Germany’s Angela Merkel may find herself without one of her strongest allies in demanding that wayward Euro members get their fiscal houses in order and France is likely to see its credit rating deteriorate. To me, this suggests a heavy recession in Europe could be in the offing, something that bodes ill for the world economy, and which could set the stage for additional sovereign debt crises.
But for today, the market seemed to be more focused on good earnings. The focus seems justified: after the market close, Apple blew the doors off analysts estimates for the quarter.
