According to ThomsonReuters, the “forward 4-quarter” earnings estimate for the SP 500 fell slightly last week to $118.03, from the previous week’s $118.24.
The p.e ratio on the forward estimate is now 15(x) even, a little higher than Factset’s 10-year average of 14(x).
The “earnings yield” on the SP 500 using the forward estimate is now 6.67%, and the Fed Model Spread (SP 500 earnings yield less the yield on the 10-year Treasury) with the 10-year Treasury close of 2.75% on 11/8/13, is 3.92%.
Remember, in the late 1990’s this spread was a negative 300 basis points. In fact at the March, 2000 high for the SP 500, when the forward estimate for the SP 500 was just $55, and the 10-year Treasury was yielding 6.40%, the Fed Model Spread was a negative 290 basis points.
More importantly, the “forward 4-quarter growth rate” for the SP 500 is 7.40% as of Friday, 11/8/13, which surpasses the 7.30% high from mid-September ’13. That is a critical metric, since a rising forward growth rate (we think) allows for p.e expansion on the SP 500. The forward growth rate is now the highest since March, ’12, when it was up near 8%.
The p.e ratio on the forward estimate is 15(x), and the forward growth rate is 7.4%, so a 2(x) PEG ratio for the SP 500 is stretched, but not unreasonable, and is about where it has been since late July ’13.
Financials have lagged since the start of the 4th quarter, which is contrary to our belief they would outperform in q4 ’13, and isn’t helping our performance, given the Financials overweight. That being said, we bought a little more JPM and BAC this last week, as (according to Bespoke), in a very overbought stock market, the Financials are the least overbought of the 10 SP 500 sectors. JP Morgan (JPM)’s legal charge in q3 ’13 continues to weigh heavily on Financials and the SP 500 as a whole: Per Thomson, the current earnings growth estimate for Financials as of q3 ’13 is +1.4%. Per Factset, and excluding JPM, the growth rate for Financials for q3 ’13 would be +15.1%. Typically Factset’s sector growth estimates are lower than Thomson’s (as a rule of thumb.)
Q4 ’13 earnings growth estimates for Financials are +23.8% as of Friday, the best growth of any sector within the SP 500. A lot of this is loan-loss reserve (LLR) releases, as Financial revenue growth continues to be punk at 0.2%. I would expect q4 ’13 Financial sector revenue growth would be higher given capital market activity and the rather tempered Treasury market. We are staying with Financials through q4 ’13. The sector needs to get out of the headlines, but with every regulator suing the big banks for past transgressions, the headlines are “p.e compressing”. (Unlike Thomson, Factset data gives revenue growth expectation for the 4th quarter in their weekly release, and Financial sector revenue growth for q4 ’13 (per Factset) is currently calling for a 10% decline. That could also be weighing on the sector. )
Technology (ex Apple) continues to show strong q3 ’13 results: according to Factset, if Apple is excluded from the Technology sector’s results, Q3 ’13 Tech sector earning growth would be would be +11.8%. ThomsonReuters does not segregate Apple’s results from the rest of the sector, with the Thomson estimate for Tech sector earnings for q3 ’13 year-over-year growth currently 8.4%. Microsoft had a good week, up 6%, on Rick Sherlund’s comments that Alan Mullaly was more likely than not to be a final candidate for Ballmer’s position. (Long AAPL, MSFT and overweight Tech);
Within Basic Materials, our only 3 holdings are Alcoa (AA), Freeport (FCX) and US Steel (X). US Steel looks the best actually. We might add to Alcoa (AA) at $8.50, for one last time. The Basic Mat sector is just 3% of the SP 500 and is about 70% Chemicals, of which we own little to no exposure. We prefer the non-gold miners at this point, due to valuations and technicals. (Long AA, FCX, and X, and overweight Basic Mat with a 4% – 5% portfolio weighting);
Consumer Discretionary continues to be on fire, both from a sector performance perspective in 2013, and an earnings perspective. Thomson data notes that Consumer Discretionary earnings growth is +20.4% as of 11/8/13 for q3 ’13, while Factset has a 10.4% earnings growth rate for the sector. The Homebuilders and Internet Retail (read Amazon) are the biggest contributors to the sector per Thomson. (Long Amazon, and like LEN and TOL in the $20’s );
Energy continues to weigh heavily on the SP 500 at 11% of the index as the Refiners have dragged down earnings growth for the sector for q3 ’13 and since October 1. The oil service companies have performed well, with HAL being our only long in the entire sector. Expected earnings growth for the sector has fallen from -0.7% as of October 1 to -7.7% today. That being said, XOM and CVX traded better following their earnings reports last week. (Underweight Energy, but the Refiners are getting interesting);
Consumer Staples: Whole Foods (WFM) in which we have a 2% position, guided lower for 2014 this week, and since the retailer is a member of the food and drug retailers subsector of the SP 500 and thus a Staples member, we looked to see if the disappointing guidance for the specialty store would impact the sector, and there seems to be little impact. Consumer Staples, by their nature are a defensive sector, and comprise 10% of the SP 500 by market cap. We like WFM at $50. We haven’t run the numbers yet from earnings results or evaluated the change in forward estimates, but we will do so shortly. Wal-Mart reports this week and we’ll have our preview over on www.seekingalpha.com. Could be a beneficiary of the decline in gasoline prices. (Long WFM, WMT, and neutral weight the sector);
Every SP 500 sector has had their earnings growth boosted relative to the October 1, ’13 estimate, for y/y growth, and every sector has had their Q4 ’13 estimates reduced from their Oct. 1, ’13 q4 estimate. This is pretty typical.
Our assumptions for q4 ’13:
Financials will outperform, notably large banks and broker-dealers (which as of 11/8/13 is not the case);
Q4 ’13 Earnings growth for the SP 500 will be the strongest in 2 years, but we wont start getting results until mid-January ’14. We still think that will be the case, and the SP 500 could grow earnings over 10% in q4 ’13, when all is said and done;
2014 earnings growth expectations have remained stable so far through q4 ’13. Current expectations are for 11% growth in 2014.
Conclusion: the earnings story remains better than most pundits give credit for, although it remains a stock-pickers market within those sectors. We continue to believe that earnings will remain a net positive for the SP 500, and supportive of the SP 500’s valuation, which seems fairly-valued right here.
It is getting tougher to find truly undervalued stocks, which we define (like everybody else) as companies whose stock prices are at a significant discount to their perceived “intrinsic value”. We use an earnings-based model that gives more of a valuation premium for current growth, and combine that with a Morningstar discounted cash-flow valuation, which is by their own admission a conservative valuation model, and average the two to get some semblance of an “intrinsic value”. Ultimately, all valuation models are flawed to some degree or another, so don’t forget to take gains and manage risk.
Thanks for reading. The SP 500 earnings story remains a positive in our opinion.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA