By Michael Tsang and Adria Cimino
Oct. 12 (Bloomberg) -- Investors outside the U.S. are purchasing companies in the Standard & Poor’s 500 Index at the cheapest valuations on record, their buying power boosted by a seven-month decline in the dollar.
The S&P 500 is priced at 19.9 times earnings, the biggest discount to the MSCI World Index of 23 developed countries since May 2003, according to monthly data compiled by Bloomberg. For Europe-based money managers, currency translations push the average cost for a dollar of U.S. profits down to 13.6 euros, the lowest level ever relative to global equities and a discount that investors in America have never enjoyed, data compiled by Bloomberg show.
Overseas investors that hold almost $2.5 trillion in U.S. equities are getting a bigger slice of corporate America with each euro, yen and pound they spend just as S&P 500 companies from PepsiCo Inc. to General Electric Co. post higher overseas sales. While more losses in the dollar would cut returns, the last time U.S. stocks were this inexpensive, in 2003, the S&P 500 began a four-year, 62 percent advance.
“What you’re getting is the opportunity to buy global companies that have become cheaper because of the dollar and more competitive,” said Antony Gifford, a London-based manager at Henderson Global Investors, which oversees $87 billion. “If you can buy global secular growth at a discount because it’s dollar listed, then why wouldn’t you?”
Stocks Advance
The S&P 500 climbed 4.5 percent to 1,071.49 last week, the biggest gain since July. Data from the Tempe, Arizona-based Institute for Supply Management showed U.S. service industries grew in September after 11 months of contraction while Alcoa Inc., the largest U.S. aluminum producer, reported an unexpected third-quarter profit as the New York-based company cut jobs and raw-material costs faster than analysts projected.
Futures on the S&P 500 were little changed at 8:44 a.m. in London. The MSCI World slipped 0.2 percent, while Europe’s Dow Jones Stoxx 600 Index added 0.3 percent as Royal Philips Electronics NV reported an unexpected third-quarter profit.
The dollar fell 11 percent against the euro and yen and 7.4 percent versus the pound in the past six months. The currency was driven down as the U.S. government and Federal Reserve lent, spent or guaranteed $11.6 trillion and the central bank kept interest rates at near zero to combat the worst recession since the 1930s.
The U.S. Dollar Index traded as low as 75.767 last week, 6.7 percent above its record low of 70.698 in March 2008.
Earnings Gap
Profits for U.S. companies have dropped less than those in the MSCI World Index, helping increase the valuation gap with the S&P 500. Santa Clara, California-based Intel Corp.,Goldman Sachs Group Inc. in New York, GE and 28 other S&P 500 companies are scheduled to report results this week.
The MSCI World has surged 66 percent since March 9 through last week as its companies reported an average 40 percent decline in second-quarter earnings, data compiled by Bloomberg show. The S&P 500 rose 7 percentage points less even as its companies posted a profit decline that was 11 points smaller.
The MSCI World was valued at 27.7 times the earnings of its 1,659 companies in September, exceeding the S&P 500’s ratio by 7.75 points, according to monthly data compiled by Bloomberg. That’s the cheapest level for the benchmark gauge for U.S. stocks since May 2003, when the index was beginning to recover from a 2 1/2-year bear market that cut its value by 49 percent.
‘Positive Bias’
“The valuation for the market is still below normal levels,” said Jason Pride, director of research at Haverford Investments, which oversees $6 billion in Radnor, Pennsylvania. “We still believe there’s a fairly good, positive bias in the direction of the market.”
Foreign investors owned $2.47 trillion in U.S. common equity as of June 30, 2008, according to data from the Treasury Department. That’s equal to about 16 percent of the total value of the American stock market, data compiled by Bloomberg show.
Net foreign purchases of U.S. shares rose to $28.6 billion in July from $19.1 billion the previous month, the Treasury said. Overall international demand for long-term U.S. financial assets weakened in July as investors cut purchases of bonds.
Officials in emerging economies such as China and Russia have questioned the dollar’s dominance in the global economy as the federal budget deficit reached $1.4 trillion in the year ended Sept. 30, according to the Congressional Budget Office. The Treasury will release August data for net transactions by foreigners in long-term U.S. securities on Oct. 16.
Paris and Frankfurt
For overseas investors buying stock with currencies that appreciated versus the dollar, shares of S&P 500 companies may be an even bigger bargain relative to global equities.
Adjusted for euros, earnings for S&P 500 companies are about 50 percent cheaper than those in the MSCI World, data compiled by Bloomberg show. That makes U.S. stocks less expensive now for money managers in Paris and Frankfurt than they were for American investors near the end of the bear market in 2002, when S&P 500 companies sold for a record 42 percent less than the average global ratio.
Investors in the U.K. can buy a dollar of profit generated by S&P 500 companies for an average of 12.8 pounds, a 54 percent discount to the MSCI World, while annual per-share earnings of U.S. companies cost 1,820 yen, 34 percent less than the MSCI World.
Using the weighted exchange rates of the six currencies in the Dollar Index -- the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc -- the S&P 500 is currently valued at 14.7 times earnings. The S&P 500 last month traded at the biggest discount to the MSCI World on record, when adjusted for the six currencies, monthly data compiled by Bloomberg show.
Owning Profits
Converting U.S. corporate profits into foreign currencies at today’s rates would eliminate the discount in the S&P 500 created solely by exchange. Priced in dollars, the U.S. index is 27 percent cheaper than the MSCI World, close to the biggest gap in six years.
Adjusting the price of the S&P 500 for currencies in the Dollar Index is a way of gauging the relative cost of U.S. earnings to overseas investors and predicting which country’s stocks may rise or fall more, said Jack Ablin, chief investment officer of Harris Private Bank in Chicago.
“The U.S. stock market is on sale,” said Ablin, who helps oversee $60 billion. “On a level playing field, the dollar is cheap to our trading partners’ currencies, so they’re able to get a reasonably priced S&P 500. It’s an argument that makes sense.”
While the drop in the dollar may entice more international money managers and provide a boost to U.S. profits, more weakening would erode the value of American stocks owned by overseas investors, offsetting gains in share prices.
Snubbing Dollars
The S&P 500’s 58 percent rebound from a 12-year low on March 9 shrinks by 22 percentage points when measured in euros and 15 percentage points in yen, Bloomberg data show.
Central banks are increasingly snubbing dollars in favor of euros and yen, data compiled by Bloomberg show. Nations reporting currency breakdowns put 63 percent of the new cash into euros and yen in April, May and June, data from London- based Barclays Capital show. That’s the highest percentage in any quarter with more than an $80 billion increase.
“The decline in the dollar makes it less expensive to buy U.S. equities -- that’s a fact,” said Walter Harecker, a Vienna-based fund manager at Constantia Privatbank AG, which oversees $15 billion. “But keep in mind that with the depreciation of the dollar, you’ll have a loss on that. Then it’s not a good effect.”
‘More Cautious’
The profit growth forecast for S&P 500 companies by analysts for 2010 is 11 times faster than the expansion in U.S. gross domestic product projected by economists surveyed this month, the highest ratio on record, data compiled by Bloomberg going back 60 years show. The average ratio is 6.1.
“We’re getting more and more cautious with the rally we’ve seen,” Harecker said. “Valuations aren’t cheap anymore, considering the health of the economy.”
Lower prices relative to the world boosted American stocks in the past. The benchmark gauge of U.S. equities ended a three- year slump in 2003, surging 26 percent as the Fed held overnight borrowing costs at 1 percent and the economy expanded at an average of 4.6 percent in the last three quarters. Over the next four years, the S&P 500 added another 41 percent to reach a record of 1,565.15 on Oct. 9, 2007.
The S&P 500 has become at least 10 percent cheaper than the MSCI World based on earnings on two other occasions since 1995, in June 1998 and August 1999, monthly data compiled by Bloomberg show. Both times the S&P 500 climbed at least 14 percent over the next year, outperforming the MSCI World by an average 4.9 percentage points, Bloomberg data show.
Higher Profits
A weaker local currency is also helping to boost profits at U.S. companies, which are generating more of their revenue internationally. Last year, S&P 500 companies had 47.9 percent of their sales abroad, the highest level since at least 2003, data compiled by New York-based S&P and Bloomberg show.
The decline in the dollar makes American companies more competitive outside of the U.S. because their exports become cheaper to sell, while the value of foreign-currency denominated sales increases in dollar terms.
PepsiCo, the world’s largest snack maker, reported a third- quarter profit last week that beat analysts’ estimates, helped by an increase in international sales. The Purchase, New York- based company said currency translation lifted sales at its European unit by 14 percentage points and added 19 points of revenue to its Latin America foods division.
PepsiCo, GE
Currency translation accounted for 6 percentage points of the 8 percent reported gain in PepsiCo’s operating profit.
A weaker dollar may also help bolster earnings at GE, which generated 53 percent of its revenue from abroad last year, data compiled by Bloomberg show. The Fairfield, Connecticut-based company that makes everything from mammography equipment to jet engines and refrigerators is scheduled to post results Oct. 16.
‘It’s best to invest more in U.S. stocks,” said Louis de Fels, a Paris-based manager at Raymond James Asset Management International, which oversees about $35 billion. “They are benefiting from a weak dollar and that’s not about to change. The more the dollar declines, the more exports will be strong.”
To contact the reporters on this story: Michael Tsang in New York at mtsang1@bloomberg.net; Adria Cimino in Paris at acimino1@bloomberg.net.
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