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US: Market Valuations At Multiyear Lows
September 1, 2010

Weaker-than-expected 2Q 10 growth has sparked fears of a double-dip recession, sending valuations of the S&P 500 to multiyear lows


Author : iFAST Research Team



Untitled Document

Chart 1: Imports from EU rebound faster

Chart 2: US  Imports coming off a low base

Chart 3: Growth moderating, but not double-dipping

Chart 4: Valuations plunge on economic concerns

 

Key Points

  • 2Q 10 growth revised downwards to 1.6% (from 2.4%) on an annualised q-o-q basis
  • Underlying components strengthen: PCE growth revised up from 1.6% to 2%
  • Inventory restocking revised downwards, but companies invested more in equipment and software
  • Imports surged more-than-expected, net exports deduct 3.37% from overall growth
  • Blip in imports, weaker USD should boost exports in 2H 10
  • Watching leading indicators for signs of a double-dip
  • Economic growth appears to be moderating; no signs of a double-dip recession yet
  • S&P 500 traded at just 12.6X 2010 earnings (as of 30 Aug 2010), lowest since crisis

 

GDP revised downwards, but not as much as expected

2Q 10 GDP growth for the US economy was revised to 1.6% quarter-on-quarter (annualised rate), down from the 2.4% reported in the advance estimate. While this was lower than the 3.7% annualised quarterly expansion in 1Q 10, growth was still better than the 1.3% median consensus forecast.

Underlying components of GDP demonstrating strength

A 1.6% annualised quarterly growth rate is understandably slow, and the latest growth figure may send short-term investors running for the exit. However, a closer look at the underlying numbers reveals that critical GDP components have actually gained strength, and not deteriorated as the overall growth figure may suggest.

Personal consumption expenditures (PCE), the largest component of US GDP, actually expanded by 2% (quarter-on-quarter annualised) in 2Q 10, an upward revision from the 1.6% growth in the advance estimate (see Table 1). In terms of percentage contribution to the final growth figure, PCE contributed 1.38% (see Table 2).

Gross private domestic investment expanded at 25% quarter-on-quarter annualised (+28.8% in the advance estimate), as inventories rose less-than-anticipated. On the other hand, investment in equipment and software actually rose by a larger-than-expected 24.9%, suggesting that businesses are beginning to put their huge cash hordes to use.

Imports the main detractor

Excluding net exports, growth would have been 5% for 2Q 10. However, imports surged 32.4% in the quarter and vastly exceeded exports, resulting in a 3.37% deduction from overall GDP growth for net exports (see Table 2). In the advance estimate, net exports deducted 2.78% from GDP growth.

We believe weak net exports stem from the relatively weaker euro in 1H 10 (decreasing the competitiveness of US exports) as well as a rush of orders for inventory restocking, as demand outstripped supply. As shown in Chart 1, US imports from the EU gained 21.3% year-on-year in June, a much stronger increase than exports to the EU (+9% year-on-year).

We do not anticipate that imports will weigh on GDP by the same magnitude in the quarters ahead, given the recent stabilisation of the euro vis-à-vis the USD, and expect growth in imports to normalise to the longer-term average of about 7-8% (see Chart 2). we previously incorporated too low an estimate for import growth, and have since revised our forecast for US 2010 GDP growth downwards to 3%, from 3.7% previously, to take into account the impact of stronger-than-anticipated imports.

Growth moderating, economy not double-dipping

Much has been made of the high unemployment rate and troubled US housing market, which has led to talk about the US heading into a double-dip recession. Granted, existing home sales figures are dismal, and unemployment remains elevated at levels consistent with recessionary conditions. Nevertheless, the latest GDP report continues to demonstrate healthy growth in private investment, while consumption appears to be gaining traction.

A check on the Conference Board Leading Indicators shows that year-on-year growth figures are moderating (to 7.1% in July 2010), but remain strongly positive. As shown in Chart 3, the leading indicators have declined on a year-on-year basis going into every recession since 1960, and we will be watching this index closely to ascertain if a double-dip recession is on the cards. At the moment, both leading indicators and the latest GDP report suggest that we are merely seeing a moderation in the pace of growth, and not heading back into recession. We are also mindful that leading indicators have previously dipped twice (in 1966 and 1996) without any severe repercussions (see Chart 3), which can happen after a sustained period of economic recovery.

Worries over slowing economy has sent valuations to lowest levels in years

Given current investor pessimism, the US equity market has declined 6% on a year-to-date basis (in USD terms, as of 30 August 2010). Yet, despite concerns over the economy, 2010 and 2011 earnings for S&P 500 companies have been revised upwards by 3.5% and 4.6% respectively, leaving the estimated PE for the S&P 500 at just 12.6X (as of 30 August 2010), the lowest level since February 2009. Prior to the recent financial crisis, the S&P 500 was last valued at about 12-13X forward earnings in 1994 (see Chart 4).

With earnings expected to rise further in 2011 and 2012, we think that investors have a rare opportunity to buy quality US companies at the lowest valuations in many years. Economic data has been disappointing of late, but current low valuations already appear to be factoring in slower growth for the US economy. We are mindful that the economy remains fragile but believe that double-dip recession fears are overblown at this juncture, and maintain our 4.0 star “very attractive” rating on the US equity market.

 

 

 

Table 1: GDP Components (Annualised quarter-on-quarter change in %)
 

1Q 09

2Q 09

3Q 09

4Q 09

1Q 10

2Q 10*

2Q 10**

Gross domestic product

-4.9

-0.7

1.6

5

3.7

2.4

1.6

Personal consumption expenditures

-0.5

-1.6

2

0.9

1.9

1.6

2

Gross private domestic investment

-42.2

-18.5

11.8

26.7

29.1

28.8

25

Exports

-27.8

-1

12.2

24.4

11.4

10.3

9.1

Imports

-35.3

-10.6

21.9

4.9

11.2

28.8

32.4

Government consumption expenditures and gross investment

-3

6.1

1.6

-1.4

-1.6

4.4

4.3

Source: US Bureau of Economic Analysis, * denotes official advance estimate, ** denotes latest revision
Table 2: GDP Components (Percentage contribution to overall GDP growth %)
 

1Q 09

2Q 09

3Q 09

4Q 09

1Q 10

2Q 10*

2Q 10**

Gross domestic product

-4.9

-0.7

1.6

5

3.7

2.4

1.6

Personal consumption expenditures

-0.34 -1.12 1.41 0.69 1.33 1.15 1.38

Gross private domestic investment

-6.8 -2.3 1.22 2.7 3.04 3.14 2.75

Exports

-3.61 -0.08 1.3 2.56 1.3 1.22 1.08

Imports

6.48 1.55 -2.67 -0.66 -1.61 -4 -4.45

Government consumption expenditures and gross investment

-0.61 1.24 0.33 -0.28 -0.32 0.88 0.86
Source: US Bureau of Economic Analysis, * denotes official advance estimate, ** denotes latest revision

 



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