US bull market could be waning as profit growth slows

Five years of profit growth exceeding 17 per cent is poised to slow in the Standard and Poor's 500 Index, reducing returns as the bull market ages, according to Leuthold Group and Barclays. Equity price gains approaching 25 per cent annually will weaken to 3 per cent over the next decade as profit expansion reverts to its rate since 1929, said Doug Ramsey, the chief investment officer at Leuthold.

Jonathan Glionna of Barclays says overseas markets are generating too little demand to push the S&P 500 up more than 1 per cent in the rest of 2014. While neither Ramsey nor Glionna see the bull market ending, measures of sentiment are turning lower amid an advance that has gone virtually uninterrupted for more than two years.

Investors are buying more hedges than any time since 2008 following a rally that has added $15 trillion to equity values.

“Temper expectations over the next several years,” Ramsey, who oversees about $1.7 billion at Leuthold in Minneapolis, said. “It’s dangerous to assume that we’re going to have above-average earnings growth from current levels. Earnings are not depressed like where they were in 2009.”

The SandP 500 rose 1.2 per cent last week to 1,955.06 as signs of a slowing economy stoked bets central banks will leave interest rates near record lows for longer, overshadowing escalating tensions in Ukraine. The benchmark measure for American equity has fallen 1.7 per cent from a record close of 1,987.98 reached on July 24th. Its futures climbed 0.5 per cent at 11:57 a.m. in London today.

The S&P 500 has climbed 5.8 per cent in 2014, compared with 16 per cent at this time last year and 12 per cent in 2012. While the index has closed at record highs more than 20 times this year, the advance is slowing with valuations at the highest levels since 2010 and investors preparing for the withdrawal of Federal Reserve stimulus known as quantitative easing.

"QE has been a nice tailwind and as the tailwind begins to fade, top line growth needs to pick up," David Lafferty, the chief market strategist for Natixis Global Asset Management in Boston, said. "We've returned to trend earnings and future expectations for stocks should mirror earnings growth."

While analysts surveyed by Bloomberg expect earnings to expand by more than 8 per cent a year through 2016, Ramsey at Leuthold said investors should prepare for profit growth to have less of an impact on prices. Using a formula that smooths out income over five years, the SandP 500 is trading at a price- earnings ratio of about 21, his data shows. In the eight decades ending in 2008, American companies expanded earnings at an annual rate of about 5.3 per cent, according to data compiled by Leuthold. Should that rate prevail over the next 10 years and profit multiples revert to the median level of 16.7, the S&P 500 would reach 2,646 by 2024 -- an annual price appreciation of 3 per cent, Ramsey said.

“Valuations are already pretty elevated,” he said. “It’s dangerous to assume normal stock market returns over the next 10 years, normal being 10 per cent, because valuations put forward some of the future returns into the present.”

Bloomberg