Excerpted from Provident Investment Management’s June investment comments
The market continues to march higher. Recently the S&P 500 eclipsed 2,400 and returned 7.2% for the year through April. This strong start for 2017 is on top of the 12% advance for 2016. FactSet Research reported on May 12 that the forward-12-month P/E ratio for the S&P 500 is 17.5, 15% higher than the five-year average (15.2) and 25% higher than the 10-year average (14.0). Investors don’t seem bothered, as a widely followed measure of anxiety, the Chicago Board Option Exchange Volatility Index, or VIX, has declined to its lowest level since 1993.
When the market trades at historically high levels investors should not be so complacent. However, corporate earnings and economic data have created the environment for higher stock prices.
According to FactSet, 91% of S&P 500 companies have reported first-quarter results. Using estimates for the remaining companies, FactSet expects first-quarter sales growth of 7.8% and earnings growth of 13.6%. If these figures hold up they represent the fastest growth since late 2011. The recovery in the energy sector has provided the largest boost to sales and earnings, but excluding energy, sales and earnings growth are still strong at 5.9% and 9.4%, respectively.
Analysts expect this stronger growth to continue for the balance of 2017, with sales and earnings for the entire year growing 5.3% and 9.9%, respectively. For 2018, analysts are even more optimistic, projecting earnings growth of 11.7% on slightly slower sales growth of 4.7%. Rapid earnings growth is a key component fueling higher stock prices.…
…For now, accelerating corporate earnings and economic growth support the stock market. However, with elevated stock prices it is more important than ever to select companies with the right balance of growth and reasonable valuation.