Speaking of Forward Earnings:
Great article from Jeff Miller’s A Dash of Insight published yesterday on the importance of “forward earnings” when evaluating both the stock market and your individual stock holdings. Truth be told, it was Jeff Miller that encouraged me to start http://fundamentalis.com, which was designed to be an earnings-related blog. Jeff and I knew each other from our days together at Jim Cramer’s www.thestreet.com, where we were both contributors, and he saw the earnings-related posts I did on occasion on the Columnist Contribution site. At a meeting in May ’12, (we are both Chicago-area advisors) Jeff encouraged me to develop the earnings-related work and see if I could develop a following, and further flush out the sector and macro-related earnings data that ThomsonReuter’s publishes.
The point being that www.Fundamentalis.com, was really Jeff’s idea. This blog has gotten some decent traction, and is now being copied in a number of places. I am seeing more and more bloggers focus on earnings data. In addition, FactSet and John Butters, who I corresponded with at ThomsonReuters many times, is now writing/publishing a sector-earnings commentary at Factset. He does a nice job with his weekly work. The point being that FactSet is now competing with ThomsonReuters on the weekly earnings info, and Factset is providing diffrerent perspective on the data. (My nephew came up with the Fundamentalis name, which is Greek or Latin for Fundamentals. Thanks, Ry.)
I have been tracking ThomsonReuters data since 2001, both the quarterly and annual estimates, and the forward-estimate data. It is a real geek work at its finest, and I can get lost in navel-gazing around the numbers, but there is important info in this data.
The data isn’t foolproof. One major faulty interpretation I made was in the summer of 2008, staying bullish, when the forward earnings estimate didn’t peak until July, 2008, almost 8 – 9 months after the market topped. You can’t focus solely on the earnings data and / or the forward estimate. Judgment and intuition still count. (As Buffett once said, “beware of geeks bearing models”.)
Remember, “price” and its direction are ultimately the best indicator you have.
Per ThomsonReuters, “This Week in Earnings”, the foward 4-quarter estimate of the SP 500 slipped a smidge to $116.74 from last week’s $116.81.
The p.e ratio on the forward estimate is now 14.5(x) versus the expected 2013 earnings growth for the SP 500 of 6.9%.
The “earnings yield” on the forward estimate is now 6.90%.
More importantly, the year-over-year (y/y) growth rate of the forward 4-quarter estimate is now 6.56%, exceeding the previous peak of 6.50% on March 1, 2013.
This is one additional twist to Jeff Miller’s article on the importance of forward earnings: It isn’t just the absolute dollar estimate that is important, but I also think that the “rate of change” of the forward estimate that helps drive p.e expansion for the major indices.
We track the rate of change every week, and the fact it broke out to a new high this week, just as the SP 500 closed at a record of 1,692.09, is probably not a coincidence.
The point being that with the SP 500 earnings estimate of $116.74 at a record high, and the growth rate of the forward estimate improving, or still accelerating, the SP 500’s p.e ratio, can continue to expand.
This could be one reason this bull market is so hated. The treatment of earnings by the mainstream media is quite bad, and it is usually negative, while that forward estimate has been slowly creeping higher since late July, August ’12, and it appears to be pulling the market along with it.
With about 100 companies reporting Q2 ’13 earnings, y/y growth in earnings is +2.8%, while revenue growth is +1.1%. 65% of the earnings reports have beaten consensus EPS, while 49% have beaten revenue consensus.
The pattern is pretty identical to Q3 ’12, Q4 ’12 and Q1 ’13 earnings season thus far. Expect Q2 ’13 earnings growth to end up +5% – 7%.
By July 26th or the end of next week, about half the SP 500 will have reported q2 ’13 earnings.
SP 500 earnings gradually declined off the productivity-driven earnings boom following the Financial Crisis of 2008, when quarterly earnings growth was between 20% – 30% for a most of 2010 and early 2011. The year-over-year growth rate of SP 500 slowed until Q3 ’12 when it hit its nadir of +0% – 1% and since then has been steadily growing once again. The near-term high of the SP 500’s forward estimate growth rate of 6.56% is a good sign. It needs to continue to work higher over time.
So why track sector earnings data ? Well, it was late last summer that we started noting the stability in the Financial sector’s earnings estimates, here, here and here, on this site. We’ve been pounding the drum on Financials as an overweight for some time, and it has worked well both in Q2 ’13 and for full-year, 2013. This week’s data show that Financials grew earnings 25% in Q2 ’13, up from the estimated 17.5% from July 1, most of that driven by the phenomenal results of the brokers. Financial’s are growing 25% y/y, while the Sp 500 is growing just 2.8% this quarter.
The XLF (Financial ETF) is up 26.5% year-to-date as of Friday’s close, while the BKX is up 29%, neither of which return include dividends.
Although none of our work is ever construed to be advice, the Financial sector estimates continue to show stability, for the remainder of 2013. Q4 ’13 earnings expectations for the sector are looking for +25% y/y growth with no downward pressure. That is amazing, and tells me we could have a very strong 4th quarter in terms of market returns this year.
Telecom: We were puzzled by the sharp downward revisions last week to Telco earnings estimates until we checked with ThomsonReuters, and found that Sprint (S) was dropped from the SP 500 index after the acquisition by SofBank. There are only 6 companies now remaining in the Telecom sector. Why doesn’t Standard & Poor’s just roll Telco into the Technology sector and be done with breaking out Telco as a separate sector ? There is no reason for this sector to be reported on its own. (no Telco names)
2014 Estimates: It is still a bit early but what we look for at this time is not the absolute expected earnings growth rates for sectors, but more the trend relative to the SP 500 as a whole. What tipped us off to the Financial sector last fall was that Financial sector estimates were remaining stable, as the SP 500 as a whole were getting lowered. Relative growth… Basic Materials is expected to have the best earnings growth in 2014 as it stands right now, however, that was also the case for 2013, until the downward revisions kicked in the last two quarters. Basic Mat numbers are still getting revised lower for 2013, so it is too early to overweight the group.
Microsoft (MSFT) and Intuitive Surgical (ISRG) both had a tough week. Microsoft ended the June quarter with $77 billion in cash on the balance sheet. Since the March ’09 market low, MSFT has averaged $6 bl in free-cash-flow per quarter, and currently returns about 50% of the free-cash to the shareholder in the form of the dividend and share repurchases. That means MSFT is adding $3 bl to the balance sheet cash position EVERY quarter, which in fact they are doing. NOW would be a perfect time to return capital to the shareholder, either in the form of a special dividend (not likely) or a share tender, or a new, larger ASR (accelerated share repurchase) program. An ASR would likely appease ValueAct, the hedge fund activist now agitating for change at MSFT, and it would reward current shareholders for being patient, and suffering through Ballmer’s “give it up for me” fiasco at one of the more recent product rollouts. (Wow, did that look bad for Steve.) ISRG had a tough week as we detailed here and here. The drop on Friday morning was horrific, but the stock recovery above that 50-month moving average on Friday, as ISRG bounced from$357 to $393, closing near its high, was nothing short of remarkable. We haven’t bought any yet, and may not, but a re-test of Friday morning’s lows are likely in the next year, and that would get us interested. This is a perfect example of what investing in high-multiple growth stocks looks like. Things can get ugly in a hurry…(Long MSFT)
Given the drubbing Basic Material’s sector estimates have taken, that is the one group we are watching for better opportunity ahead, particularly if China can start growing again, and Japan continues its recovery. That sector is down and out from a numbers and sentiment perspective and some of the stocks look to be bottoming.
Bought some TLT and IEF this week. Here is a chart on Treasury sentiment picked from @RyanDetrick at Schaeffer’s Investment Research. This was really a buy based on bullish sentiment data in equities, bearishness in bonds, and seeing 86% of the SP 500 trading above its 50-day moving average.
Cornerstone Macro is an Economic Research Team featuring Nancy Lazar as Chief Economist. This group was spun out of ISI a few months ago. Great piece this week by Nancy on how Michigan (and Detroit) are benefiting from the US Manufacturing Renaissance in the Midwest. Detroit filed fior bankruptcy this week – could mean a new start for the beleaguered city ? Michigan is doing better.
Japan holds UpperHouse elections on Sunday, July 21st. The only thing that bothers me is that – according to mainstream media – Abe is expected to win a bigger majority to further help his agenda around re-stimulating the Japanese economy. It is taken as a given that the elections will go his way and he will have a bigger majority to get things done. That always worries me when the commentary is so one-sided. We added to the EWJ and DXJ here in the last month. We will be listening and watching how the Nikkei opens Sunday night at 8 pm central time here in the US.
ISI Research notes that since Abenomics instituted, Japan retail sales +60% in the late, 2012. Abe and Kuroda need to keep pushing the rock up that hill. Continued recovery in Japan will certainly help that global growth theme.
The only sector that is not overbought is Telecom, and that is rated just neutrally on the overbought / oversold scale.
The SP 500 has regained overbought status quickly after dropping 5% off the May 22, ’13 high.
The one key stat that we think bears repeating out of Bespoke is that as of the end of April ’13, Domestic’s (100% of rev’s within US) had outperformed International’s by over 600 bp’s in the SP 500 (probably a lot of that retail). By early July that outperformance spread had narrowed to 300 bp’s. I do think International’s will continue to gain relative strength within the SP 500 as a whole, particularly if China grows and Japan growth continues. It is not a “tomorrow” trade though.
Thanks for reading and stopping by.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA