Earnings Perspective 2/23/2013: Industrials and Financials showing Good Relative Earnings Strength

Per ThomsonReuters, the “forward 4-quarter” earnings estimate for the SP 500 this week fell slightly to $112.32, from $122.37.

The cumulative decline in the forward estimate since the Jan 4th, 2013 all-time high tick of $113.88 is $1.56.

If you are wondering why this is the least bit relevant, let’s compare it to one year ago: in early January, 2012, the “forward 4-quarter estimate” hit $107.67, and by the end of February had been revised lower by $1.99 to $105.68 by 2/24/12.

The small but important distinction there, and one of the reasons the forward-estimate continues to grow year-over-year, is that we saw sharper downward revisions throughout 2012, which are now the comparison for 2013.

The point being that, despite the financial media cacophony around earnings, while there is still pressure on forward estimates, that pressure is gradually becoming less severe.

Using the $112.32 estimate from this week, the SP 500 is trading at 13.5(x) that forward estimate, on expected earnings growth for 2013 of +9.3%.

For full year, 2012, the SP 500 grew earnings 3.9%, but returned 15.98% for the calendar year. Compare this to 2011, where the SP 500 grew earnings north of 10%, but the benchmark returned 2.5% for 2011.

The earnings yield for the SP 500 with Friday’s close is 7.41%, and the year-over-year growth of the forward estimate is 5.91%.

With Q4 ’12 earnings season now thought to be officially concluded with Wal-Mart’s earnings release of Thursday morning, Q4 ’12 earnings have grown 6% year-over-year (y/y) while revenue growth grew +3.6%. (Long WMT).

This is consistent with our prediction that Q4 ’12 earnings growth would be at least 5%, which would be consistent with the pattern we have seen historically.

 Stat of the week:

Earnings estimates for Q1 ’13 are now calling for expected growth of +1.3%, down from +4.3% as of January 1, and +7.1% as of October 1, 2012. Q1 ’13 estimates could go negative before the quarter is out.

This would bring Q1 ’13 earnings growth roughly in line with the Q3 ’12’s actual 0% to 1% growth, which we thought would have been the nadir for the cycle.

My own opinion is that when we see Q1 ’13 numbers starting April 15th, Q1 ’13 earnings will continue to be better than q3 ’12’s low for the cycle.

Here is the quarterly expectations for Industrials and Financials as of 2/22/13: the first column is the expected growth as of February 22nd, the 2nd column is the expected growth as of Jan 1, ’13 and the 3rd column is the expected growth as of October 1 ’12:

Q4 ’13:

Financials: +23.6%, +26.1% n/a

Industrials: +20.5%, +18.1% n/a

SP 500: +13.1%, +17.6%

Q3 ’13:

Financials: +11.3%, +12.2%, +13.7%

Industrials: +10.4%, +8.8%, +15.8%

SP 500: +10.1%, +11.4%, +15.9%

Q2 ’13:

Financials: +19.3%, +19.2%, +18.6%

Industrials: +2.5%, +2.1%, +6.8%;

SP 500: +6.4%, +8.4%, +10.4%

Q1 ’13:

Financials: +9.5%, +9.6%, +8.4%

Industrials: -1%, +1.7%, +6.7%

SP 500: +1.5%, +4.3%, +7.1%

Q4 ’12: (actual)

Financials: +17.1%, +14.6%, +28.9%

Industrials: -4.4%, -5.5% +3.4%

SP 500: +6%, +2.9%, +9.9%

Perspective: as the reader can quickly see, Industrial and Financial sector estimates are showing better relative strength as we move through 2013, despite estimates being cut for 2013 for the SP 500 as a whole.  Some of the strength in Industrials might be due to GE’s recent news of additional share repurchases from the sale of NBC-U to Comcast. With the announcement of the sale of the remaining 50% of NBC-U,  GE immediately increased the amount of their share repurchase plan. Ironically, if you are looking for one company that might encompass the Industrial and Financial sector strength, it could be GE. With GE Capital still being 30% of operating profit, the financial services arm of GE is not going away anytime soon. (Long GE)

Industrials are 11% of the SP 500 by market cap, with Aerospace & Defense being 20% of the sector or roughly 2% of the SP 500 as a whole. With worries about sequestration, we think this is where the value is or long-term investors. We are doing a lot of fundamental, bottoms-up, homework on Lockheed-Martin (LMT) and a few other names in the space. GE – as a true conglomerate – gets you exposure to Aviation and Financial Services, not just Industrial. Also, despite GE still being well below its 1999 – 2000 high of $60 per share, GE is still the 3rd largest company in the SP 500 by market cap.

Financial Services: Financials are roughly 17% of the SP 500 by market cap. We think BAC is big influence on earnings estimates. We think BAC is a tangential way to play the housing recovery. In 2013, BAC will benefit from improving capital ratios, a dividend likely in 2013, possibly more share repurchases, and the improvement in housing. (long BAC)

Financials grew revenue in q4 ’12, +20%, the highest revenue growth rate in years, driven by Life & Health insurers and Broker-Dealers. Don’t expect that number to repeat itself anytime soon.

We think BAC and JPM are the best values in banking today. (long BAC, JPM)

We also think SP 500 earnings will gradually improve as we move through 2013: the second half of the year, will be stronger than the first half of 2013, thanks to easier compares later in 2013. Expect full-year 2013 SP 500 earnings growth to be high single digits, better than 2012’s +3.9%.

Conclusion: Sentiment around forward SP 500 earnings estimates continues to be too negative in our opinion. Stick with the sector’s that are showing decent relative strength like Financials and Industrials. There is some talk about an “Earnings Cliff” on the horizon, but after the last 12 years, and particularly the earnings pressure we saw in ’08, when the forward estimate fell from $102 to near $60, we think it would take another near economic meltdown to produce a similar drop in earnings estimates. The market malaise and continuing pessimism have thrown a wet blanket over future expectations. Earnings Cliff worries have not show itself in credit spreads yet either. Like Q4 ’12, we think future earnings will continue to surprise to the upside through 2013.

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The HYG, and JNK high yield bond ETF’s are now officially oversold on the weekly charts. We bought a little of each this week. (Long HYG and JNK);

Why hasn’t inflation been an issue, even though every other day since early 2009, there has been a guest on CNBC talking about the horrid inflation we are about to see ? Bob Doll, the new CIO at Nuveen Asset Management, and former CIO at Merrill Lynch, thinks it is because the money multiplier remains subdued. The “velocity” of money is not yet where it should be, (and this is my conclusion) probably because the growth rate of the US economy remains well below potential. I have heard Bob speak, both at a Nuveen lunch here in Chicago, and recently to the CFA Society of Chicago, and he has talked about the money multiplier both times. Inflation is not an issue yet. Contrary opinion, we happen to agree with.

The consumer is the focus these days, with the payroll tax hike, sequestration and lackluster retail sales. Brian Wesbury, a pretty good economist at First Trust here in Chicago, thinks that the “financial obligations” ratio, which is after tax income divided by consumer debt like mortgages, car payments and credit cards is at a multi-year low. In other words, consumer’s debt service ability is at a multi-year high, hopefully from refi’ing mortgages the last few years at generational low rates. Check Wesbury’s blog and the recent January retail sales comments for thoughts on the “financial obligations” ratio;

We still like Coach (COH) even as it slips below the 200-week moving average, towards the August, 2011, lows near $45.70 – $45.76. We’d buy more at that level. Great brands do not disappear overnight.

St. Louis Fed’s graph on CPI inflation. The CPI is the narrowest of all inflation indicators, but you can see how the Fed was fighting “deflation” in late 2008, and 2009.

We still like Wal-Mart (WMT) as a stock for client accounts. The earnings per share beat on Thursday was partially due due to a lower tax rate, but the stock closed the week above the key previous, all-time high of  $70.25 high of January, 2000. WMT management always guides conservatively. (long WMT).

Final thought: it still surprises me how the Street turns so bearish so quickly. Now everybody is expecting a correction, simply because we’ve been overbought for so long. Todd Harrison once wrote that, “markets can correct through TIME or price”, meaning just moving sideways can work off an overbought condition. The pessimism around earnings, the consumer, the government headlines, sequestration, gas prices, etc. etc. is surprising. Seemingly no good news anywhere, EXCEPT Q4 ’12 earnings weren’t too shabby.

Thanks for reading and stopping by:

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

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