S&P 500 Profits

With a recent strengthening of the economic indicators, profits estimates are again being
revised up, but in typical modest fashion. SP 500 profits are expected to rise 47% in 2010
to around the $83.70 level reflecting about 8% sales growth and higher profit margins from
dramatic cost cutting. The bulk of the sales increase reflects higher unit volume, with pricing
power remaining modest. Higher profit margin is somewhat overstated by a rising level of
share buy ins as cash flow rises and companies gently increase underlying leverage and ROE%.

Analysts in sum now look for 2011 profits to rise to a record $94.80 per share, for a gain of
13.3%. Confidence in this good an increase is on the rise, in line with the recent improvement
in the economic indicators and further liberalization of fiscal and monetary policy. To do this
well in a continuing environment of modest pricing power, companies will again need to show
good volume gains and further operating efficiencies.

I am using a number around $90 a share for SP 500 eps in 2011. That would represent a 7.5%
increase over the current estimate for 2010. I am using the more conservative figure because
I am not as yet willing to make more generous growth assumptions beyond mid 2011, when
the Fed must again make another decision regarding quantitative easing. Moreover, I want
time to assess to what extent companies are willing to increase hiring and whether the
markets for private sector shorter term credit will begin to loosen up.

I continue to think there is ample slack in the US economy and that recovery / expansion
can easily proceed for another 4-5 years before the system would become well and truly
overheated. This view strongly suggests further significant progress in earnings and
dividends in the years ahead.