By Michael Tsang and Lynn Thomasson
May 11 (Bloomberg) — The biggest earnings-season rally since 2002 has pushed 34 percent of the companies in the Standard & Poor’s 500 Index above analysts’ price targets for the next year, raising concerns about the pace of the recovery. The S&P 500 was within 5 percent of the combined price projections of more than 1,700 securities analysts last week after gaining 14 percent since Alcoa Inc. reported first-quarter results on April 7. Caterpillar Inc., the largest maker of excavators, and Citigroup Inc., the bank rescued by $45 billion in U.S. taxpayer funds, are among 170 companies that trade above their average price estimates, data compiled by Bloomberg show. So far, analysts have resisted lifting price and earnings targets after the S&P 500 surged 37 percent from a 12-year low in March. The combination of falling profit predictions, rising valuations and higher costs for options that insure against losses are raising investor concerns that the rally may have come too far, too fast.
“To expect this to continue to move onward and upward from here would be unrealistic,” said Leo Grohowski, chief investment officer at Bank of New York Mellon Wealth Management, which oversees $132 billion in New York. “It would be healthy for the market to take a breather and allow some of the fundamentals to catch up.” With more than a third of the companies in the benchmark index for U.S. stocks overvalued compared with their price targets, the S&P 500’s fair value is 970.21, compared with its 929.23 close on May 8, data compiled by Bloomberg show. Banks Lead Market The S&P 500 fell from a four-month high today, losing 2.2 percent to 909.24, as banks said they would sell more shares. The decline was the largest in three weeks. The index rose 5.9 percent last week, erasing this year’s losses, after results from the government’s examination of banks reassured investors and the Labor Department said the pace of job cuts slowed in April. Financial stocks led the measure’s advance, surging 23 percent. More than 200 companies in the gauge have risen at least 50 percent since this year’s low on March 9. Prices of almost half the companies in the measure are within 5 percent of the fair value target, according to data compiled by Bloomberg. The S&P 500’s steepest nine-week rally since the 1930s began as the biggest U.S. banks said they were profitable in the first quarter, President Barack Obama outlined $787 billion in spending and tax cuts and the Treasury unveiled plans to finance as much as $1 trillion in purchases of lenders’ troubled assets.
Lack of Support “Estimates suggest there isn’t that much further to run because equities are fairly valued,” said Hayes Miller, who helps manage $30.9 billion at Baring Asset Management Inc. in Boston. “Earnings growth for 2009 and 2010 can’t support prices too much higher than where we are today.” S&P 500 companies beating profit forecasts outnumbered those that trailed by 2-to-1. A majority of companies in each of the index’s 10 industries posted results that beat projections, data compiled by Bloomberg show. Caterpillar reported 14 times more per-share profit on April 21 than the consensus estimate. Since then, 15 of 19 analysts cut second-quarter forecasts by about 53 percent and 16 reduced their outlooks for the third quarter by 66 percent. No one covering Peoria, Illinois-based Caterpillar boosted estimates, Bloomberg data show. The company’s 30 percent surge since its earnings release has pushed the shares to $39.64, 25 percent higher than the $31.83 analysts on average say the company is worth. ‘Sudden Jamming’ Nick Heymann at Sterne Agee & Leach Inc. in New York rates Caterpillar a “sell” and expects the stock will fall 39 percent, based on his price target of $24. “We’re going to have a sudden jamming on the brakes of investors’ enthusiasm for early-cycle stocks when they realize they made a big mistake,” he said in a telephone interview last week. “If you’re not properly positioned in your portfolio, you may find that you go through the windshield.” Since New York-based Citigroup reported per-share profit that was 48 percent higher than the consensus on April 17, more than 50 percent of the analysts reduced their estimates for the second quarter and half cut their projections for all of 2010, Bloomberg data show.
“The equity market has priced this recovery and then some,” said Barry Knapp, U.S. equity strategist at Barclays Plc in New York. “It looks pretty expensive to us.” Knapp, the most bearish of the 10 strategists tracked by Bloomberg, says the S&P 500 will decline 19 percent from last week’s closing price, based on his year-end target of 757. Gains have already pushed the index past projections from Barclays, Credit Suisse Group AG, Deutsche Bank AG, HSBC Holdings Plc and Morgan Stanley. None of the 10 forecasters polled by Bloomberg News has raised outlooks for 2009. Leon Goldfeld, chief investment officer of the Hong Kong unit at HSBC Global Asset Management, which oversees more than $350 billion, said in an interview on May 4 that it’s “hard to see” enough profit growth to justify higher stock prices. The firm’s strategy will be to reduce its holdings of equities and move into bonds and cash, he said. Chop and Grind Options traders are increasing bets the rally is about to end. History also shows rallies from bear-market lows suffer setbacks before climbing. The last time U.S. stocks broke out of a bear market in 2002, a seven-week, 21 percent surge from the trough gave way to a 15 percent drop before the bull market resumed. During the Great Depression, a 47 percent surge after the stock-market crash in 1929 was followed by at least six retreats of at least 25 percent. “We’re going to be in a very volatile, chop-and-grind type of market,” said Christopher Hyzy, chief investment officer at Bank of America’s private wealth management unit, which oversees $200 billion. He said the S&P 500 may retreat as much as 10 percent as investors focus on the ability of companies to increase earnings to pre-recession levels. “We’ve been shown that there is a small light at the end of the tunnel, it’s dim but getting brighter, and that’s why stock prices have come this far this fast,” Hyzy said from New York. “Now, it’s all about ‘show me.’”