First, we never managed to get to our sector revenue analysis this week, and for that we apologize. With all the earnings coming out, we have our hands full until mid-August, when we will be able to write some more reflective and analytical pieces.
For now though, per ThomsonReuters, the “forward 4-quarter” estimate for the S&P 500 fell this week to $108.23, still above the end of June’s $107.25, but down from last week’s $109.01. The S&P 500 is still trading at 12.5(x) these forward earnings estimates and close to the record print of $111 per share.
For the 2nd quarter, year-over-year S&P 500 earnings growth per ThomsonReuters is 7.2%, but after excluding Bank of America (very good compare vs q2 ’11), actual growth is closer to 1%. Overall revenue growth for the S&P 500 remains at 1%, about where the estimates were several weeks ago.
For the 3rd quarter, 2012, expected year-over-year earnings growth has fallen to -1.7%, where we expect S&P 500 earnings to bottom for this cycle. That is our educated guess, given the weak compares from 2011 around the Japan earthquake and tsunami, and the debt downgrade and European issues we saw in August – September, 2011.
That brings up a good topic: if you look at a chart from the S&P 500, we have followed an almost identical pattern in 2012, as we did in 2011, except that late last week and this week, the market action has begun to de-couple – in a positive way – from the previous pattern. This week the S&P 500 rose about 5 points, while last year, for the same week ended August 5th, the S&P 500 fell 90 points. (Thanks to ISI Research for tipping us off to this fact, but ISI referenced just Friday’s action and instead we chose to look at the entire week’s change versus last year. Still the credit goes to ISI for bringing this to our attention.)
Last year at this time, we were in the throes of the brutal European and Congressional deadlock correction, even though earnings were still growing year-over-year by 17%. This year the stock market has started to decouple from the pattern, but year-over-year growth has slowed to 1%.
Our largest sector overweights remain technology, industrials and financials. Per ThomsonReuters, Industrials have had the highest beat rate of any sector with 83% of those industrials which have reported earnings, beating estimates. Since July 1, year-over-year earnings growth for the industrial sector has risen from 10% to 15%, the best bump of any of the 10 sectors of the S&P 500, and the highest year-over-year growth of any sector but financials. We remain long Boeing (BA), United Technologies (UTX), MMM, GE, Fed-Ex (FDX) and a few others in client accounts. ThomsonReuters made the point that the Industrials were not seeing the same revenue beat rate as earnings, but I attribute a lot of that to currency. Most companies with any kind of international exposure, are seeing negative currency impact on revenues in q2 ’12. The fact that the industrials can make that up with expense savings or share repo’s shows financial flexibility and doesn’t detract from the quality of earnings in our opinion.
Healthcare has been a pleasant surprise: on July 1, year-over-year growth for q2 ’12 was expected at just 0.1%, today that is +4.8%, thanks in part to large-cap pharmaceuticals. In addition an investor gets 3.5% – 4% dividend yields with large-cap pharma. Intuitive Surgical still worries me a little. We have a small long in the stock in one long-term account and with this recent correction, ISRG is still trading below it early June low of $498. Wait for a close above $498 before buying, but know that this is a high p/e growth stock with a lot of risk.
The two sectors where we have little to no exposure are telecom and utilities. I think Verizon (VZ) and AT&T (T) are WAY stretched technically, and way overbought. We’ve never been big utility investors so but I can’t help but think a lot of what is driving these stocks is:
a.) a big push into the dividend trade;
b.) Very low interest rates, which makes the dividend yields look attractive;
c.) The consistency and stability of the earnings growth (certainly not a bad thing);
We looked at our AT&T and Verizon spreadsheets this weekend, both telco’s have a dividend payout-ratio of 60% or more, a statistic which should tell you light years what management’s think about the growth prospects of the business. Earnings retention for future growth is just 35% – 40% for both T and VZ. For most of Industrial America, the dividend payout ratio is closer to 30% and the earnings retention ratio is 70%, for reinvestment back in the business, or just the opposite of the two major telecoms.
One of the few utility stocks we follow technically – Southern Company (SO) – has been overbought on the weekly chart since late 2011.
If interest rates should ever rise suddenly, it will be interesting to see how telco and utilities react to the higher rates.
Everything seems to be on hold until the Presidential election and the key issues around the fiscal cliff are resolved. For that reason, I think S&P 500 earnings bottom in the 3rd quarter of 2011.
We are going to leave readers with a brief analysis of the S&P 500 by sector. The first column (in parentheses) is the sector weight, while the 2nd and 3rd columns are the expected full-year 2012 sector earnings growth rates both as of Friday, August 3rd, and on July 1:
Cons discr (11%) 11.8% and 11.6%
Cons stapl (11%) 4.4% and 6.4%
Energy (11%) -9.9% and -5.7%
Financials (14%) 19.3% and 24%
Hlthcare (12%) 2.2% and 2.2%
Industr (11%) 10.3% and 9.9%
Technology (20%) 10.4% and 7.1%
Basic Materials (3%) -6.9% and -0.7%
Telco (3%) -1.6% and 0.9%
Utilities (4%) -7.3% and -7.8%
A lot of retail earnings get reported over the next few weeks. We’ll be out with a preview of CVS’s earnings report on www.seekingalpha.com, which is due out Tuesday morning. We’ll also hear from Department Store retailers like Macy’s, (M) on Wednesday , and Nordstrom (JWN) and Kohl’s (KSS), on Thursday. Home Depot (HD), Lowe’s and I suspect Walmart (WMT) is due out the week after this one. (Long WMT and HD, small position in CVS.)
Thanks for dropping by.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA