Per ThomsonReuter’s “This Week in Earnings”, the forward 4-quarter estimate for the SP 500 rose $0.17 last week to $115.88 from the prior week’s $115.71. While that seems pretty insignificant in terms of the amount, what is interesting is that historically at this time in the quarter, given the trends in q4 ’12, and q1 ’13, the dollar forward estimate was still declining, relative to prior weeks.

The p.e ratio on the SP 500’s forward estimate is now 14.8(x), which could be construed as a little rich given the expected 5% earnings growth in calendar 2013, the 7.3% forward 4-quarter growth rate, and the 8% expected growth rate for calendar 2014. However, bottoms-up estimates for 2014 are looking for 11% earnings growth for 2014 as we detail below, and the trends have been stable.

The earnings yield on the SP 500 is 6.78%.

Importantly, the growth rate of the forward 4-quarter estimate ended last week at 7.30%, the exact same level from the prior week.

Given the current full-year EPS estimates, the SP 500 is expected to grow earnings 5% and 8% (using the current earnings per share estimates for 2013 and 2014 of $109.01 and $117.34), numbers which have been consistent for some time. Given the p.e ratio relative to the expected growth rates for ’13 and ’14, the SP 500 does look a little stretched here.

FedEx Corporation (FDX) and Oracle (ORCL) were two notable companies reporting financial results for the August quarter last week. FDX traded higher, up 9% on the week on cost cuts and better volumes, while Oracle lowered forward guidance, based on a tough comparison. Despite what looked like weak guidance for ORCL, the stock still rose +4.9% for the week.

One white hot sector since last fall, Aerospace / Defense, saw one of its components – Rockwell Collins (COL) – issue weak guidance this past week. COL’s revenues for the quarter are expected to fall 2%, EPS at least 10%, which implies margin pressure. Lockheed Martin (LMT) is up 39% this year. Our two primary defense holdings are United Technologies (UTX) and Boeing (BA), and Boeing is really held more for Boeing Commercial Airline than Boeing Defense. (Long UTX, BA).

We got more housing data next week starting with Lennar (LEN) and KB Home (KBH) reporting earnings on Tuesday, as well as Case-Shiller and FIFA data Tuesday and Wednesday. Even Bed Bath (BBBY) which is a retailer tied to household spending, reports Thursday Sept 26th.

**Sector data: Percentage of Stocks above 50-day Moving Average (followed by p.e ratio): **

Cons Disc: 84%, 21.5(x), +18.7%

Cons Spls: 65%, 18(x), +10.8%

Energy: 74%, 13(x), +10.8%

Fincls: 68%, 13.5(x), +9.2%

Hlth Care: 85%, 18(x), +9.3%

Industrials: 100%, 17(x), +10.9%

Basic Mat: 84%, 19.5(x), +18.1%

Technology: 86%, 16(x), +11.8%

Ute’s: 42%, 15(x), +4.4%

Telco: 33%, 22(x), +10.9%

SP 500: ?, 14(x), 11%

Source: Bespoke for % data, and p.e ratio data, ThomsonReuters for expected 2014 sector growth rates

**Interesting Trend to Data for Expected 2014 Earnings Growth:**

(First column is week ending, the 2nd column is the expected rate of 2014 earnings growth for SP 500, as it trended over the 3rd, quarter, 2013)

9.20.13: +11.4%

9.6.13: +11.3%

8.30.13: +11.2%

8.16.13: +11.2%

8.2.13 +11.0%

7.19.13: +11.3%

7.5.13: +11.5%

* Source: ThomsonReuters

It was at this time last year that the Financial Sector was starting to look better relative to the other sector and SP 500 revisions for 2013. I’m starting to think similarly about the SP 500 for 2014, given that while 2013’s expected earnings growth has been revised lower from +7.3% to +6.3% the last quarter, 2014 expected growth is remaining stable. However, we won’t really have a definitve feel for 2014 until SP 500 companies start giving full-year guidance on the January – February, 2014 conference calls, and we see the size and quantity of revisions if any.

Per ThomsonReuters data, the dollar earnings per share estimate for 2014 is currently projected 8% growth, but the bottoms-up estimate is expecting 11%. These two should converge over time.

It bears watching, and the best sector in terms of expected earnings growth for 2014 (today) is Consumer Discretionary, at +18%.

Remember, if the SP 500 can print 10% – 11% earnings growth in 2014, then a 20(x) – 22(x) p.e ratio would be consistent with the higher end of fair value or 2(x) PEG, as the current market is trading at presently.

If we assume 2013’s final EPS number is where the estimate is today at $109.01, and we multiply that times 11% expected growth, we get $121 per share for 2014’s expected ending EPS. At a 20(x) multiple that equals 2,420 as an ending value for the SP 500 on 12/31/14, or a total projected return from Friday’s closing value of 1,709 of 42%.

Even if we use a 16(x) multiple for 2014, we arrive at a 1,936 ending value for the SP 500 on 12/31/14, or a 13% return from Friday’s closing SP 500 value.

Readers can quickly see how important p.e expansion and the market p.e is for generating capital gains for the SP 500.

(To be clear to readers there are a number of assumptions here that still need to play out, BUT an informed reader will understand the logic. This is an estimate and only an estimate based on the current growth estimates, which change weekly.)

Also to be completely forthcoming, our SP 500 projected return estimate for 2013 on January 1, 2013 was between 5% – 15%. The year has turned out better than we thought.

What we need to see to confirm this is to watch that forward growth rate of 7.3% and see if it moves higher towards 11% as we move through the 4th quarter. That will be the key tell, that the 2014 earnings estimate is solid.

- We still expect the SP 500 to have a strong 4th quarter. The SP 500 could end 2013 up as much as 25%;
- We still like Financials into year-end 2013, particularly the capital-market sensitive stocks;
- We added some duration this past week, and will look for a bond rally into this coming week and next. Our positions will be very short-lived in terms of interest-rate risk;
- I think Ben and the FOMC are one strong nonfarm payroll report away from tapering;

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As mentioned above, we added some duration this past week in the form of the MUB and the HYD, which are actually municipal ETF’s. The HYD is a high-yield muni ETF, and high yield muni bonds have very long durations. The muni market got a bid this past week, with Wednesday’s Treasury rally, and then Puerto Rico issues seeming to pass. The muni market has been rocked with state pension issues, Detroit’s default, worries over Puerto Rico and the possibility that muni’s long-held tax preference will get eliminated as Congress and the President scour the country for tax revenue.

What might help the bond rally this coming week is this article from Ryan Detrick of Schaeffer’s on how this coming week is * historically very poor* for stock returns. Detrick is a great prognosticator. You should be following him on Twitter at @ryandetrick. If we have a down week for the SP 500, and Treasury’s dont rally very much, that is your tell.

This chart from Norm Conley from Sept 7th is still relevant relative to Chairman Ben Bernanke and the decision not to taper this week. There is no “cost” to extending easy money today. There just isn’t any inflation anywhere. (Conley is a great blogger – love his charts and graphs. @JAG_Norm is his twitter link.)

Great article from Bob Brinker’s Twitter Feed (from Barron’s) on how more states are lowering taxes to attract retirees and wealth / capital. Florida is the gold standard. Will never happen in Illinois. This state is truly backward.

We added to Hewlett (HPQ) throughout most of last week. One of the few really oversold stocks we could find. At $21 per share and a $40 billion market cap, HPQ is trading at a little over 2(x) cash-flow (ex the balance sheet cash). $40 billion less the $13 billion cash on the balance sheet as of 6/30/13, is roughly $27 billion, divided by the 4-quarter trailing cash-flow of $12.85 billion equals 2.1(x) price to cash-flow (ex cash) valuation. Just 3(x) free-cash-flow ex cash. Dividend is reasonable in terms of earnings payout. Yes it is old tech, but we can be patient with it.

Final comment: we thought our article on Wednesday on SeekingAlpha about Ben Bernanke perhaps hearing Ghost’s of the 1930’s in decidng not to taper, was a good one, but it didn’t get much traction. There is little “cost” to extending easy money today, given that there is no inflation, but I also wonder if traditional monetary policy is becoming less and less effective. A discussion for another time.

* Conclusion: *We continue to look for a strong end to 2013, but we are starting to scrutinize 2014 earnings estimates for what 2014 will look like in terms of relative earnings growth. Financials wont have the earnings performance in 2014, that they saw in 2013, as the numbers atnd currently. Consumer Discretionary looks like it is on track to have another strong year in 2014, given current estimates. The top 3 sectors so far in 2013 in terms of performance are Healthcare, Consumer Discretionary and Financials. Within client accounts we remain overweight equities at 65% – 70% of accounts, and underweight fixed income.

This could be a tough week for the tough week for the stock market, given historical performance, but if the SP 500 is down sharply and we DO NOT get a good bond market or Treasury rally, that would be our signal to re-short the Treasury complex via the TBF and TBT.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

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