This week I link to a 20 year view of the SPX (1993 - 2013). SPX Weekly Over this period,
the SP 500 has returned about 7.2% annually before dividends. Despite some extraordinary
interim volatility, the long term performance is pretty decent. SPX net per share also rose at
about a 7.2% annual rate over the 20 year interval, and that latter trend is moderately above
the long term average. It is also an interesting time slice because the p/e ratio back in the early
1990s was elevated on cyclical earnings as it is presently.
To maintain adequate return on both assets and capital, the SP500 companies managed their
business portfolios very aggressively, often preferring to buy rather than build, as well as
using a greater proportion of cash flow to buy in common stock. They have benefited very
substantially from refinancing borrowings at steadily lower interest rates and have cut their
pension contributions by raising actuarial rates of return and where possible freezing the
traditional defined benefit and contribution plans by substituting 401ks in their stead. To
maintain return on assets, most companies have struggled to boost asset turnover but have
been very successful in using technologies and in running very tight ships on labor costs
to boost profit margins. This has been strong performance in an increasingly globalized market
place where newer, lower cost competition has been chipping away at pricing power.
Moreover, business failures are written off aggressively at the end of economic expansion
periods. Investors, who prize current operating earnings above all, have graciously overlooked
the mammoth write-offs that crop up over recession intervals. Some folks may think the top managements of big companies are pretty smart, but when you look at the huge write-downs
that have been taken, you cannot help but conclude that the boyz are not that smart. But, they
are smart enough to pay themselves kings' ransoms while leaving table scraps for the rank and
Remember the old formula for return on equity %. It goes as follows: Profit margin x asset
turnover = return on assets x total financial leverage = ROE%. For many companies, the
focus has been on boosting profit margin and on maintaining leverage via share buybacks
and refinancing ever more cheaply via lower interest rates. I should also add that by
exhausting plant, some companies have been able to boost asset turns (sales divided
by total assets).
Looking forward, with interest rates around historic lows, the bulk of gains from lower
rates has been achieved, and aging plant will eventually have to be replaced. There will also
be a little pressure to fund pensions more heftily as the boomers retire and finally, it will
be increasingly more difficult to keep pushing profit margins higher via leaning on the
work force as the fat has largely been trimmed, leaving the bone and sinew. Before long many
companies will be looking at the need to re-work business strategies.
On the technical side, the indicators which accompany the chart show a strongly overbought
and extended position for the SPX.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!