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Eye on the Market | April 9, 2012
J.P.Morgan

Q&A on the USA, with a watchful eye on the risk of giant man-eating plants; Spain

Now that P/E multiples have risen off the bottom, what’s the outlook for P/E multiples and earnings from here?
The return on the S&P this year has been a function of P/E multiples rising (from 11.3x to 12.9x), a big part of which has been Apple (3% of the S&P index, 15% of S&P’s YTD returns). As shown below, earnings revisions have been negative for 2012, but analysts are still optimistic about 2013. According to Morgan Stanley, analysts are forecasting the highest percentage of companies posting 2013 margin expansion since 1970, and by a very wide margin. In our view, it will be difficult for multiples to rise further unless earnings outperform expectations, particularly if Europe’s structural problems take center stage again.

Revisions to consensus EPS by quarter
Index, 12/30/2011 = 100
[Chart labeled: 4QE +1%, 3QE -1%, FY12 -1%, 2QE -2%, 1QE -3%]
Source: FactSet.

The place that worries me the most: Spain. It ranks at or close to the bottom in a lot of categories (see table), and its growth outlook is poor. Historically, this kind of thing has not ended well. Spain has defaulted 13 times since 1500 AD; it’s probably going to take a lot of bilateral aid and ECB financing to prevent another one.

Michael Cembalest
Chief Investment Officer

Win, Place and Show:
The problem of Spain

[Table Columns]
[Column 1] Number of dwellings to population | [Column 2] The only country I can find that's in worse shape than Spain is: Greece
Non-financial corporate debt to GDP | Ireland
Corporate sector debt to cash flow | Portugal
Construction sector debt/assets | None
Banking sector branches per 1,000 people | None
Reliance on foreign capital (Net Int. Inv. Pos.) | Ireland, Portugal
Real estate as % of household assets | None
Housing overhang (as per CEPS) | Ireland
Commercial RE exposure % of bank assets | None
Encumbered banking system assets, % | Greece
World Bank labor rigidity, Europe | None
Intra-European real effective exchange rate | Italy
Shadow economy, % of GDP, OECD | Italy, Greece
Unemployment rate | None
Production time per unit | Italy
Reliance on ECB to finance sovereign debt | None
Bank lending to HH/NFC, last 12 months | None

HH/NFC = households and non-financial corporations
Sources: IMF, OECD, EU, World Bank, CEPS

Sources
“States of Bankruptcy, Part I: The Coming State Pensions Crisis”, Joint Economic Committee Republicans, Representative Kevin Brady and Senator Jim DeMint, December 8, 2011
“The Trillion Dollar Gap, Underfunded State Retirement Systems and the Roads to Reform”, Pew Center, February 2010
“Fiscal Policy in a Depressed Economy”, DeLong (Berkeley) and Summers (Harvard), March 20, 2012
Moody’s US Municipal Bond Defaults and Recoveries, 1970-2011
IMF Country Report 11/216. “Spain: Selected Issues”, July 2011

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