Stock Market -- Longer Term Perspective

With 1995 as base year, the SP500 is tracking an 8.8% positive
trendline, right in line with earnings. Coupled with a 1.8%
yield, the implicit return is 10.6% per year. I have assumed a
3.0% inflation rate to compute the multiple. So, the market is doing
fine, based on trendline growth of 8.8% and a moderate inflation level.
Now, it is critical to notice that 8.8% growth is well above the very
long term norm of 6.0 - 6.5%. Over the past 10-15 years, ROE% has
risen strongly up to over 17%. The dividend payout rate on earnings
has dropped below 40%. With a high plowback of earnings, the SP500
has implied eanings growth potential in excess of 10%. Most companies
generate more cash than they can profitably re-invest, so they buy
back shares and generate acquisitions. Balance sheets are stronger
now but are still aggressively managed. Many companies could pay out
more in dividends without harming growth, but since senior management
bonuses are so often tied to maxxing out eps, they keep more cash.
Companies have also been skimping on capital expenditures, but there
is still excess capacity in the system.

US only earnings growth has decelerated with an economic slowdown, and
this has recently lead to greater interest in the big multinationals
which have large foreign bases of revenue and have been benefiting
from a moderately weaker US$ and faster offshore growth.

This longer term view of the market helps drive home the point of
the need to recognize how the market has been led by a historically
rapid rate of earnings growth backed by high growth corporate financial
internals. Fretting bears have consistently missed the importance of
a powerful earnings trend, and longer term bulls risk taking this
performance for granted.

When I look at companies, I am more interested in return on total
assets (ROA%) than ROE%, since companies can pump the latter through
borrowing and share reduction. In looking at ROA%, I am interested
not just in a company's ability to maintain profit margins but asset
turnover -- sales divided by assets. You would be surprised how many
companies can cover over declining asset turn with increased leverage.