Not surprisingly, then, the VIX (^VIX -0.37%), Wall Street's fear gauge, plumbed its lowest level since March 15 on Friday, even dipping below 12 on an intraday basis. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)
The earnings drum is beating
As I've argued several times in this column, the rally that began off last year's June low is being driven by valuation, rather than earnings, with the market willing to pay a higher multiple for a dollar of earnings, as investor risk aversion continues to dissipate. There are good reasons for this -- to a certain extent -- as fears of global macro dislocations have receded. However, I think it's worth sounding a few words of caution.
At a price-to-earnings ratio of 14.3, the S&P 500 may not look expensive on the basis of 2013 operating earnings per share; however, that figure masks the range of valuations across the different sectors. In a yield-starved environment, investors have been snapping up shares that pay rich dividends, and that enthusiasm is reflected in the P/E multiples of the consumer staples, telecoms, and utilities sectors, at 17.4, 19.7, and 16.4, respectively.
Furthermore, I continue to believe that the S&P 500's current forward multiple understates how expensive it really is. Consider that the 14.3 P/E assumes that operating earnings per share will rise nearly 15% year-on-year in 2013. That figure strains credulity; 2012 growth was 0.4%. On this point, first-quarter earnings will provide us with some clues either way, and we have a heavy week ahead of us in terms of earnings announcements, with nearly 15% of the companies in the S&P 500 reporting quarterly results, including more than a third of the Dow components -- 11, to be exact:
- Tuesday: Coca-Cola, Johnson & Johnson, Intel
- Wednesday: Bank of America, American Express
- Thursday: IBM, Microsoft, UnitedHealth Group, Verizon
- Friday: General Electric, McDonald's