Alcoa (AA) and Wells Fargo kick off the 4th quarter, 2012 earnings season this week. The key aspect to 4th quarter earnings is that typically company managements give the Street their first intelligent assessment of what the coming 12 months might look like in terms of earnings and revenue growth. From this info, analysts start to modify and fine tune their individual company models for the next 12 months.
While company managements typically issue guidance every quarter, it is the 4th quarter that is unusual in the sense that during the calendar year guidance is typically limited to the coming 3 months, but with the 4th quarter, managements at least make an attempt to give a 12-month view.
Here is one key aspect to this year’s guidance: given the two horrific bear markets of the last 13 years, and the subdued equity returns since the late 1990’s, managements have gradually taken in their “irrational exuberance” (to steal a quote from Alan Greenspan) to what can only described as somber and conservative guidance. In fact corporate managements have no reason to be aggressive in their forecasts, since equity market valuations can’t reward an aggressive estimate anyway. (Apple might be the perfect example – if a company with an expected 70% revenue growth rate can trade 7(x) earnings ex-cash, why should any other corporate CEO stick their neck out on an optimistic earnings or revenue estimate ?)
Besides corporate CEO’s not being aggressive, analysts craft their own models which have been consistently conservative as well. The guidance environment is the complete opposite of the late 1990’s. We still haven’t mentioned the quality of earnings relative to the 1990’s, which in my opinion are much higher today than just 12 years ago. There is far less dilution in the technology sector.
As of Friday, Jan 4th, 2013, and per ThomsonReuters, the “forward 4-quarter” earnings estimate for the S&P 500 is $113.88, a new all-time high forecast for the key benchmark, surpassing early October’s $112.26 estimate from the week of October 5th,, that was gradually taken lower as we moved through calendar q4 ’12.
As of Friday’s close, and with last week’s 4% rally on the S&P 500, the p.e ratio on the S&P 500 is 13(x) that forward estimate, with 10% earnings growth expected for 2013.
We’ve studied the S&P 500 earnings data closely for many years (starting back in 2000) and it is easy to get lost in the data. You have to be careful (as we weren’t) in 2007 – 2008, and not focus exclusively on the data, but listen to message of the markets as well.
4th quarter, 2012, earnings are expected to grow 2.8%, down from 9.9% expected on October 1, 2012. Here is the change in expected Q4 ’12 year-over-year earnings growth by sector for the S&P 500 as of Jan 4, 2013, (first column) from October 1, 2012 (2nd column):
Consumer Discretionary: +11.1%, +16.8%
Consumer staples: +5%, +7.4%
Energy: -1.8%, -1.3%
Financials: +14.5%, +28.9%
Healthcare: -0.4%, +2.6%
Industrials: -5.6%, +3.4%
Materials: +0.7%, +21.9%
Technology: -1.0%, +9.4%
Telecom: +5.1%, +4.1%
Utilities: +0.7%, -4.4%
S&P 500: +2.8%, +9.9%
Only Telecom and Utilities saw estimates revised higher through the calendar 4th quarter, 2012. Energy estimates remained relatively stable. Financials, Industrials, Technology, and Materials saw sharp downward revisions. As the reader can quickly see there continues to be downward pressure on earnings estimates, but I suspect the absolute numbers have bottomed with the 3rd quarter.
So, what is the point ? My educated guess is that both 4th quarter, 2012 and full-year 2012 earnings growth will come in close to +5% (we’ll know more by late January, mid February, 2013, since by that time, the majority of the 4th quarter earnings reports will be over) and the 3rd quarter, 2012, will be the bottom for S&P 500 earnings growth, coming off the 2008 Great Recession.
The History
Here is the recent quarterly S&P 500 earnings history (both actual and estimates) :
q4 ’13 +17% (est)
q3 ’13 + +10.8% (est)
q2 ’13 +7.8% (est)
q1 ’13 + 3.8% (est)
q4 ’12 +2.8% (est – actual results start this coming week – expect +5% by the end of earnings)
q3 ’12 +0.1% (actual)
q2 ’12 +8.4% (actual)
q1 ’12 +8.1% (actual)
q4 ’11 +9.2% (actual)
q3 ’11 +18% (actual)
q2 ’11 +12% (actual)
q1 ’11 +18.9% (actual)
q4 ’10 +37% (actual)
q3 ’10 +31% (actual)
q2 ’10 +38.8% (actual)
Anyone detect a pattern here ? It looks like we saw a huge “productivity-driven” earnings boom off the March ’09 market lows, that has gradually lost steam as US economy has remained below its long-run potential growth rate. Still, I do believe that q3 ’12’s earnings nadir of flat earnings growth on flat to +1% revenue growth was the bottom for the key benchmark.
2013 by sector
Here is the current S&P 500 earnings growth projections for 2013 (ranked by expected growth, by sector as of Jan 4, 2013):
Basic Materials +21.3% (flat since Oct 1 ’12 – China related ? From “Worst to First” in ’13 )
Telecom +21.1% (down slightly from Oct 1, still a strong ’13 is expected. Handset sales ?)
Financials +16.4% (interesting that for q4 ’12, financials earnings growth cut in half, but ’13 taken higher from +12.6% as of 10/1)
Consumer discretionary +15.2% (another good year expected)
Technology +12.7% ( Tech will be up 4% – 5% for 2012, when all done)
S&P 500 +10.4% (same growth rate for 2013, as we started 2012 with – more of the same ?)
Consumer staples +9.8% (will finish 2012 near 4% – 5%)
Industrials +9% (sleeper sector for ’13 given China, Japan and Western Europe recovery. +6% in 2012)
Energy +3.9% (has seen sharp downward revisions since Oct 1 for 2013 – not a good thing – from +7.8% as of Oct 1)
Healthcare +1.4% (also seeing sharp downward revisions already for 2013 – from +8.1% as of October 1)
Utilities +0.9% ( from -6.6% in 2012 to just barely positive. Never owned ute’s.)
The downward pressure on 2013 estimates already for Energy and Healthcare is interesting. Energy I expected, Healthcare is a bit of a surprise. Didn’t expect that, which is why I do this exercise every week. We’ve been lifting our healthcare weighting this year, particularly Johnson & Johnson (JNJ) given its pharma, medical device and consumer brands. More to come below.
That is it for our “data” aspect of the weekly blog. Here is our color commentary on the market(s):
Asset Class/Sector/Individual stocks updates:
* S&P 500 short-term overbought: Bespoke noted on Friday, that 88% of the S&P 500 is trading above its 50-day moving average, the highest such percentage since October, 2011. With q4 earnings starting this week, we bought some SH (SP 500 inverse ETF) on Friday to cover our downside a little bit. A lot of stocks are walking into earnings season “overbought” but that doesn’t mean they cant go further to the upside on fundamental news. We’re playing “reversion to the mean”.
The old saw or maxim in investing is that “fundamentals follow technicals”. However a change in fundamentals isn’t always preceded by a technical change.
Bottom-line, I think q4 ’12 earnings will be better-than-expected, but with 88% of the average overbought, I dont think they can be that good.
* The 10-year Treasury yield rose 20 basis points last week, from 1.71% on Friday, 12 /28, to 1.91% as of Jan 4th. Wow, that is quite a pop. Might there be a sea change occurring in the bond market ? Dick Hoey, a respected market-watcher called an end to the 30-year Treasury bull market this week on CNBC. We havent made a new low in the 10-year Treasury yield since late July (see our blog post of a few weeks ago noting this). Norm Conley had a good tweet on this topic this week:http://twileshare.com/abyd. Norm shows the upper-band of the 10-year Treasury could still rise quite a bit and not be “broken” so to speak.
Bottom-line, I think we could see higher rates in 2013, but we’d have to move a long way (according to Norm’s chart) to do permanent technical damage. Bearishness is still the prevailing sentiment in the bond market, and has been that way since 2003. JP Morgan puts out an institutional bond fund sentiment survey (or at least they did) and CONSISTENTLY bond fund managers were short their duration benchmarks off the March, 2003 (!) stock market bottom, and remained that way.
No question the risk-reward remains poor in fixed income. The Street is stretching for yield.
* As a sector, Financials still look good given earnings growth estimates. Per our opening remarks, 2013’s estimates still portend favorably for the sector. Here is another graph from Norm Conley of JA Glynn on financial http://twileshare.com/abyy outperformance. We remain overweight the financial sector which is roughly 15% of the SP 500 by market cap. (Long JPM, GS, WFC, CME, SCHW, V). We could probably use a regional bank in client portfolios.
* Basic materials, 3% of the S&P 500 by market cap, is expected to show the best growth in 2013 as estimates stand currently. Alcoa reports Tuesday night, Jan 8th after the bell. Here is our earnings preview found on www.seekingalpha.com:http://seekingalpha.com/article/1093321-alcoa-earnings-preview-trading-at-a-discount-to-tangible-book-for-a-reason?v=1357309641&source=tracking_notify. AA trades at a discount to tangible book, and pressure still remains on forward estimates. (long AA). Commentary around China and inventory will be noteworthy.
* A number of our portfolio laggards in 2012, really caught fire late in 2012, including Ford (F), Alcoa (AA), and Schwab (SCHW). All three stocks really had good weeks in the first week of the year too. (Still long all 3 mentioned).
* Here is a tweet from Ryan Detrick, a technician we follow that has produced some good work. http://stocktwits.com/message/11298380. The smart money doesn’t seem so smart here – there were a lot of hedge funds that opened up after 2000, but 2008 took the wind out of those sails. It is tough to do this for a living with any vehicle, i.e. hedge fund separate account, mutual fund, etc. We use separate accounts for clients, and tax-advantage the taxable money. We had an ok year in 2012. It could always be better.
* Another interesting tweet from Ryan Detrick http://stocktwits.com/message/11298287. The market is near term overbought but this graph shows how out-of-favor equities are as an asset class.
* Combine this tweet http://stocktwits.com/message/11292818, with the Bespoke data showing 88% of stocks above their 50 day m/a, and we have the ingredients for a decent pullback.
* One last tweet from Eric Platt http://twitpic.com/bsfhdx. Remember “Services” is 80% of the US GDP.
* Finally, we will keep an eye on our large-cap pharma and heathcare exposure given the trend in estimates. Our two biggest longs are Merck (MRK) and Pfizer (PFE). Dr. Mark Schoenebaum at ISI does the best work. We are also long Amgen and buying more JNJ. Not sure where the earnings pressure is coming from in the healthcare sector. Could be non-pharma related. The valuations on pharma are attractive, with stocks selling at 11(x) earnings, expecting better pipeline news, and with the ability to cut costs. Eli Lilly (LLY) guided higher on Friday, Jan 4. (No positions in LLY.)
To conclude, expect a correction within the S&P 500 here shortly, but expect Q4 ’12 earnings to come in better-than-expected, given subdued expectations. The key to individual stock trading around earnings will be the 2013 guidance. My own guess is that 2013 will be “conservatively decent”, with room for upside.
We remain overweight Financials, Industrials, and Technology in clients accounts, with a longer-term overweight in stocks vs fixed-income. These weightings have been fairly constant themes in our weekly reviews.
Thanks for reading, and for stopping by the site.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager