There has been much handwringing of late that the rally in stocks may run out of steam, either because of higher oil prices torpedoing earnings growth or due to investors taking a “risk off” approach due to turmoil in the Middle East, Japan’s nuclear crisis or a host of other worries. We have been hearing through our core (clients) and extended (allied professionals, business consultants, industry contacts, etc) network that many large, multinational companies have internal scenario models suggesting a rising chance of a surprise upside in earnings growth in the near future.
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There is a very good chance that aggregate S&P 500 earnings in 2011 will hit $100 or higher. The question that we should be asking ourselves is “what then?” Sure, if oil keeps going up and breaks through $125/ barrel, or if some other calamity creates big headwinds, 2012 earnings may not grow much. But many well respected analysts now believe that $110 or higher are possible for next year’s S&P 500 earnings. If this becomes increasingly the perception in the next 6 months, it would not be surprising to see the S&P 500 reach 1500 (a 13% gain, excluding dividends, from current levels) later this year or even 1600 (a 20% gain) if some of the world’s hotspots have calmed down.
Here are five reasons we believe investors will be handsomely rewarded owning selected U.S. blue chip multinationals over the next 3-5 years:
· U.S. multinational companies have the ability to adjust their sales focus to higher growth emerging markets, while also pursuing niche opportunities in less robust markets. China, India, Brazil and dozens of other countries are buying more goods and services of many U.S. blue chip companies.
· These same companies have the ability to adjust their expense footprint into markets with lower cost structures. An example is that several of our clients and extended network companies have moved much of their Chinese production to Vietnam, where the work is being done “cheaper and better”.
· Many of these companies are cash rich and are gushing positive cash flow. They are beginning to focus their spending on buying equipment, technology, competitors and knowledge that will help them maintain earnings momentum. In many cases, the hangover from the Great Recession is allowing them to buy these enhancers at discount prices to their true worth to the enterprise.
· Access to capital is very good for these companies. Why do they need capital when they have a lot of cash? As one CFO told us, “We can borrow at incredibly low interest rates that make the threshold return in what we use the capital for very low. A management team made up of primates could make money in this environment”.
· The Productivity engine is not out of gas. Yes, some of the inputs for productivity are pointing to slower gains in 2011 and 2012.However, we hear optimistic productivity reports from many companies in our network. An excellent study by McKinsey & Co., Growth & renewal in the United States: Retooling America’s economic engine, highlights some of the areas that could produce a surprise upside in future corporate earnings. It could also affect future inflation expectations in a very positive way – think i-Pad 2, which is more powerful than its predecessor and yet priced the same. And here’s the punch line – it has a higher profit margin for Apple than the i-Pad 1.