9.28.13 SP 500 Earnings Update: The Sentiment Shifts in This Bull Market Remain its Most Compelling Trait

Reflection of the week: when they shovel dirt on top of me, (hopefully not anytime soon), I want to go out as Mariano Rivera has left the game of baseball: much loved and at the top of my game. I’ve never really been a basebell fan, but to see the highlights of Mariano’s last game at Yankee Stadium was truly touching, and a testament to him as both a baseball player and as a person.

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The Data:

Per ThomsonReuter’s “This Week in Earnings”, the forward 4-quarter SP 500 earnings estimate slipped this week to $115.46, down $0.42 from last week’s $115.88.

The p.e ratio for the SP 500’s forward estimate is 14.6(x).

The SP 500 earnings yield using the forward estimate is now 6.80%.

The growth rate of the forward 4-quarter estimate fell to 7.02% from last week’s 7.30%, which is a sharper drop than we thought we’d see.

Essentially all of the SP 500 has now reported q2 ’13 earnings, (497 of the 500 companies) and more importantly we have companies reporting their August ’13 quarters, which gives us 2 additional months of insight into earnings.

Final Q2 ’13 earnings and revenue growth are +4.9% and +2.2% respectively.

The Q2 ’13, started with +2.9% and +1.1% earnings and revenue growth respectively in early July ’13.

The Quarterly “Bump” in the Estimate next week – Should be $119 – $120

By next week, Friday, October 4th, we should see the dollar value for the SP 500’s forward 4-quarter earnings estimate up around $119 – $120, as we roll into the new quarter, and another record high. However, extrapolating on our internal spreadsheet, let’s say we see a $118 estimate, and comparing it to October 5th, 2012’s $112.26, that is just 5% year-over-year growth, or what would be a disappointing number. We need to see not only record earnings in terms of the dollar estimate, but we should see a 7% year-over-year growth rate, which would put the new “forward 4-quarter estimate” for next week in the $120 range.

Q3 ’13 and Q4 ’13 expectations:

In my opinion, analysts have already started thinking about and modeling 2014 estimates, so q3 ’13 and q4 ’13 are likely pretty set in stone, although the Financial sector saw sharp upward revisions to q2 ’13 earnings, after earnings started being released. With q2 ’13 earnings, the banks, brokers and insurance companies started reporting earnings beats, thanks to much better credit metrics, reserve releases around mortgages, home equity and credit card losses, and also big upside revenue and earnings surprises thanks to 2nd quarter ’13 capital markets. (This is particularly true for the banks, not sure what is driving insurance company earnings. We dont have exposure to the sector.) The revenue growth for Financials is still in the 4% – 5% range, so the earnings beats are likely coming from expenses and credit.

Here are SP 500 earnings growth estimates by sector for q3 ’13 (the first column is the sector’s % of the SP 500 by market cap, the 2nd column is q2 ’13 expected earnings growth, the 3rd column is q4 ’13 expected earnings growth):

Financials: 17% of SP 500: +9.7%, +25.7%

Telco: 3% of SP 500: +7.6%, +19.5% (ignore – just 6 companies left in sector)

Cons Disc: 12% of SP 500: +7.7%, +13.9%

Industrials: 10% of SP 500: +5.4%, +17.4%

Cons Spls: 10% of SP 500, +4.8%, +6.8%

HlthCare: 13% of SP 500, +3.5%, +8.2%

Technology: 18% of SP 500, +3.3%, +7.8%

Utilities: 3% of SP 500: +0.7%, -3.9%

Basic Mat: 3% of SP 500: +0.2%, +13.4%

Energy: 11% of SP 500: -0.8%, -1.4%

SP 500: +4.6%, and +11.1%

So what is this data telling us ? Only Energy and Utilities are looking for lower q4 ’13 growth currently, than q3 ’13, which is why we are still underweight the sectors, although to be frank, we were never big Energy and Utility investors to begin with. Our “Return to Global Growth” theme is pretty commonplace today in the financial media as Europe, and Japan recover, and China looks to have turned the corner, if you believe the data.

Every sector – except Utilities and Energy – are expecting q4 ’13 earnings growth to be stronger than q3 ’13, but there is still time for q4 ’13 expectations to be revised lower as we move into year-end. We do think q4 ’13 SP 500 earnings growth, has the potential to have the first +10% y/y earnings growth since q1 ’12.

Financial sector earnings growth will dip to about 10% in q3 ’13, from q2 ’13’s +30%, which may account for the bank and brokerage stocks treading water of late, but with 25.7% expected earnings growth for q4 ’13, (even revised up a touch since July 1), we expect the sector to have a good quarterly returns in q4 ’13.

Investment conclusions as we move into the 4th quarter, 2013:

  • We think Q4 ’13 for the capital markets for q4 ’13 will be very healthy, and expect the SP 500 to have another good quarterly return, possibly north of 5% (again);
  • Per Bespoke, for the last 20 years, October, November, December monthly returns for the SP 500 have averaged about 1.5% per month. Given the strength so far YTD in 2013, it seems unlikely this year will be different;
  • We think q4 ’13 might see +10% earnings growth for the SP 500 for the quarter, given how the data is tracking, but we dont get to see the numbers until mid-January;
  • We continue to be overweight Financials: the +25% earnings growth estimate for the sector for q4 ’13 is a tell for us, in terms of capital market expectations. That +25.7% number is not ALL reserve releases and better credit data;
  • We will be watching how the earnings revisions look for 2014 as we track through q4 ’13, however we don’t expect 2014 full-year earnings estimates to take shape until the January – February conference call guidance;
  •  Where we could be wrong is that Financials might already discount all of the strong 2013 earnings growth, and that q4 ’13 turns out to be weaker earnings growth, low-single-digits. How Financials trade around q3 ’13 earnings starting mid-October is key, but we think the worst is in the stocks already.
  • I’d like to see the forward 4-quarter growth rate estimate start to track higher again after its pause the last 3 weeks. A number over 8% by mid-October would be a good sign;

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If you read only one article this weekend, this piece from Jeff Miller at “A Dash of Insight” should be it. Fantastic piece on asset allocation, and how fixed-income allocations, help manage risk in a diversified portfolio. ( A topic well understood by institutional investors, but maybe not individual or retail investors.)

Good call by Ryan Detrick on this week’s SP 500 action, although down 1.06% this week for the key benchmark is hardly something to fret over.

Bullish Treasury sentiment per Detrick is at 26%, lowest in quite some time. IEF and TLT up 0.55% and 1.55% this week, respectively.

From Norm Conley, stock market sentiment still supportive of a decent q4 ’13 rally. Bespoke, which publishes some of the best market data and analysis on the Street, noted in this weekend’s research piece that AAII bullishness fell 9 points last week, from 45.11% to 36.05%, the largest drop since August 1. For me, this continues to be the defining trait about this record bull-market rally: it takes a very small decline in stock prices to trigger large changes in sentiment. Investors turn bearish very quickly, and as long as this characteristic lasts, we think the equity bull market still has room to run, i.e the complete absence of irrational exuberance.

Two graphs from Norm Conley: the first, shows magnitude of 10-year yield spike historically, the 2nd chart shows the Treasury rally has more room to go (possibly).

Guess I better stop blogging. Some truth to this, found on Josh Brown’s blog.

Gary Morrow (@garysmorrow) worries about BAC here in this chart, but I checked EPS estimates and there is still an upward bias, albeit a gentle slope. There is better near-term growth in other financial stocks. Still long BAC, and that won’t likely change.

Morrow and a few California hedge-fund buddies have started blogging at www.ThisWeekOnWallStreet.com. Good technical analysis. Check it out.

Summary/Conclusion: we remain overweight equities in client accounts within the traditional 60% / 40% standard asset allocation. We are operating under the assumption that the SP 500 will be up nicely in calendar q4 ’13, and that q3 ’13 earnings will be more of the same. We are overweight Financials, Industrials and Technology (barbelled with New and Old tech names), with a decent sized position in Basic Materials, relative to its SP 500 weight. We own very little Energy, and no Utilities or Telco exposure. We’ve sold our Treasury short position, as of the Larry Summers announcement, and went long some Treasury / interest rate risk for clients, but I am prepared to flip back to a short Treasury position (via the TBF and / or the TBT) at any moment, or with the a move in the 10-year Treasury yield towards 2.50%. Our Basic Materials trade is a contra-trend trade right now, with Alcoa (AA), Freeport (FCX) and US Steel (X). US Steel is interesting: CNBC noted this week that X has the third largest short position in the SP 500 with 30% of X’s float shorted. The stock is trading well technically. Even Alcoa (AA) is trading better, with it being kicked out of the Dow 30. Since July’s earnings report, when AA was trading at $7.80 – $7.90, AA is up 4.5%, with the boot from the Dow too.

We’ve taken more of a buy-and-hold approach to our equity positions, and have successfully traded the long and short side of our fixed-income positions in 2013. A yield trade into the 2.40%’s for the 10-year Treasury and we would be shaving duration, and shorting the interest-rate exposure on portfolios. We added a muni high yield ETF to some taxable accounts to get a little more interest rate risk, for a trade. You can get extra duration buying a high yield muni ETF, a longer duration than all but the TLT Treasury ETF:

Here is a quick summary of our fixed-income ETF’s and our rationale for the trade:

HYD – Mkt Vector High yield Muni ETF: 5.84% yield, 11.0 years duration (a little more interest rate risk for taxable accounts)

MUB – iShares muni ETF: 2.91% SEC yield, 6.9 years effective duration (not much yield, but muni-fund outflows starting to slow)

HYG – iShares Corporate high yield ETF: 5.92% taxable yield, 4.5 years effective duration; (for tax-exempt accounts, good combination of yield and interest rate risk)

IEF / TLT – straight Treasury long exposure: IEF is 7 – 10 year Treasury ETF. TLT is 20+ Treasury ETF. Not much in yields, but given Treasury sentiment, a trade for capital gains. The TLT has an effective duration of 16.5 years, so (as one would expect) you get the most interest rate risk for your dollar.

We are ready to trade out of all of the above at a moment’s notice, and revert back to overweighting corporate credit risk, floating-rate ETF’s, and the Treasury short ETF’s such as the TBF and TBT. But given Treasury sentiment and Washington rancor, the Fed’s just might provide investors with an opportunity to make money on the long-side of Treasuries if only for a few weeks. (Fundamentalis is a not a trading blog, so we won’t update positions daily. We’ve been long a little interest rate exposure for about 10 days, and we think the 10-year Treasury yield could get to 2.50%, but that could change tomorrow. )

Thanks for reading and stopping by:

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

 

 

 

 

 

 

 

 

 

 

 

 

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