Thoughts from our Domestic Equity Team
The majority of last year’s stock market appreciation was a function of rising valuation multiples. The price-to-earnings (PE) ratio for the S&P 500 expanded from approximately 12.5 at the beginning of 2013 to just over 15 by the end of the year, a gain of over 20%. Despite this impressive rise, the market’s current PE ratio is only modestly ahead of its historical average. And while we maintain our view that stocks do not appear overly expensive based on this metric, particularly in light of the subdued interest rate environment, we do believe that for the market to move higher, earnings growth will have to be the key driver as opposed to further PE expansion. Currently, consensus expectations are for a high single-digit percentage increase in corporate earnings for 2014. Fourth quarter earnings season is just getting started, and while the majority of companies have yet to report their results, those that have, in aggregate, came in modestly ahead of expectations for both the top and bottom lines. What we believe is more important than the fourth quarter results will be the guidance given for the current year. It is likely that the market’s 2014 performance will be driven at least in part by whether those high single-digit earnings growth expectations can be achieved.
Jason Sheer, CFA
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