S&P 500 Sector View: No Kudos To CEOs For This Year’s ‘Perfect 10’

S&P 500 Sector View: No Kudos To CEOs For This Year’s ‘Perfect 10’

Here’s an interesting observation: At the rate US stocks are rising, this could be the year of the “Perfect 10,” a year when all the ten industry groups in the S&P 500 (INDEXSP:.INX) could notch gains of 10% or more for 2013, something which hasn’t been seen in nearly twenty years.

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With the S&P 500 (INDEXSP:.INX) at life highs, Citi strategists Tobias M Levkovich, Lorraine M Schmitt and Christina Wood give us a reality check on whether this awesome rally still has legs. Their Monday Morning Musings report analyzes sectors to check whether the S&P 500 (INDEXSP:.INX) has run on ahead of earnings.

Lower taxes, lower interest at play

“While many investors focus on after-tax margins which are at record levels and more consistent with stock price developments, net profits are being helped by a meaningfully lower effective tax rate and sharply lower interest expense primarily assisting the Financials sector. Nonetheless, several sectors are showing wide divergences between margin trends and stock price performance, implying their stock prices have run too far,” say the authors.

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So, are we to assume that the rally is a result only of earnings boosted by government largesse in the form of lower taxes and cheap money? Or did the economy, and business managers, have no role to play?

Sluggish operating performance of S&P 500 sectors

Eight of ten S&P sectors are generating ‘Earnings Before Interest and Taxes’ (EBIT) below 2007 highs, say the Citi strategists. Since interest and taxes are low, corporates are managing to report high post-tax net incomes.

Citi puts it candidly: “With so many sectors underperforming at the EBIT level, it is challenging to argue that CEOs and their teams have been so successful in managing their businesses as efficiently as has been stated by many market observers. Indeed, some industries actually have performed poorly given their operating margin levels, with Pharmaceuticals being a prime example.”

Prices not in sync with EBIT

Sectors such as Consumer Staples, Health Care and Industrials are overpriced compared to their EBIT fundamentals, point out Citi, and this is clear from the charts below:

2-healthcare S&P 500

3-industrial S&P 500

On the other hand, Citi says that Telecom, the one sector that could play spoilsport in the Perfect 10 party, is likely to generate better real margins in the event of improving global economic growth.

4-telecom S&P 500

However, all is not lost, and according to Citi the eight sectors, which have under-performed on EBIT, may grow their earnings yet and this “may be the needed factor for more gains in 2014 but the pattern could become more volatile.”

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Saul Griffith is an investor in stocks, commodities and forex, writing under a pen name. Saul has top accounting qualifications and extensive experience in industry and the financial markets. He also has an abiding interest in breaking news that could be a harbinger of new trends and give insight into an instrument’s potential for providing value, growth or yield.
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