Corporate earnings update – August 19th – S&P 500 nearing its early April highs

For the week, the S&P 500 finished higher by 0.87%, the Dow 30 rose 0.51% and the Nasdaq rose 1.84%, no doubt helped by Apple which closed at a new all-time high on Friday, near $648, taking out the old intra-day high of $644 from April 10th, 2012.

The S&P 500 is sitting just 4 points shy of its April 2nd, high of 1422.38 as we start the week. Most of the sectors of the S&P 500 remain in overbought territory, with the exception of utilities, but skepticism abounds.

It is interesting that 2012 was progressing almost in lockstep as a repeat of 2011’s market action until the Friday prior to the July nonfarm payroll report when we saw that week end with a strong rally that Friday, as the Treasury complex had an “outside reversal” week as well. So two powerful asset classes started to indicate that maybe – just maybe – all the market pessimism was not warranted, and that as Jeff Miller, of “A Dash of Insight” blog puts it, perhaps something might go right. (By the way, it was a great call by Ed Hyman’s ISI Group’s research department that pointed out the potential divergence in the S&P 500 at the end of July. They nailed it precisely.)

The forward 4-quarter estimate for the S&P 500 came in at $108.07 as of Friday, August 17th, and per ThomsonReuters, down from the record $111.88 on July 13th, and up from the nearby low of $107.25 in late June, and then the $105 and change estimate from late March ’12.

With 2nd quarter, 2012 earnings pretty much complete, and already half way through the 3rd quarter, q2 ’12 earnings grew 8.4% year-over-year, but excluding Financials and the easy Bank of America compare, q2 ’12 earnings grew closer to 1.5%.

3rd quarter ’12 earnings are now expected to decline -1.8%, down from the +3.1% growth expected on July 1.

We continue to believe that S&P 500 earnings are in the process of bottoming, as y/y growth has slowed dramatically over the last year, and that the 3rd quarter will be the nadir for this earnings cycle.

Per ThomsonReuters, revenue growth for the 2nd quarter, continues at 1% y/y.

Here is an interesting stat: which of the 10 sectors of the S&P 500 has the highest revenue growth in q2 ?

Answer: Healthcare (which was surprising to me).

For our earnings-related metric of the week, here is how the S&P 500 sectors rank in terms of revenue growth for q2 ’12:

Healthcare +8%

Technology +6%

Industrials +5%

Cons stple +3%

Telecom +3%

Cons disc +2%

Financials +2%

Materials -1%

Utilities -3%

Energy -12%

S&P 500 +1%

Market / trading update:

* The selloff in Treasuries continues, as the 10-year yield has now risen from 1.38% in late July to over 1.82% this week. What surprises me is how nonchalant some of the pundits are about this 10-year yield increase, somewhat similar to the drop in the Nasdaq in March of 2000. (Long TBF and TBT, and bought a little TLT late last week, for a quick trade.)

* Thanks to ISI Group in one of their weekly research pieces: corporate bond-fund inflows this year-to-date are almost $1 trillion in size. Equity fund outflows are close to $0.5 trillion. The retail investor base continues to take money from equity mutual funds. Speaks volumes in my opinion.

* Corporate investment-grade bond issuance hit a record the last few weeks. We saw $72 bl of issuance in July, and and $50 bl already in August, 2012 per Reuters. Even Moody’s, the rating agency got into the act by issuing debt at these levels. What do corporate Treasurers know that we dont ? (If you are looking for a way to play issuance from the stock market side, look at Moody’s (MCO) and McGraw-Hill (MHP), which owns Standard & Poor’s. The two rating agencies rake in the cash when issuance soars. Both stocks and companies still carry the stigma left over from the 2008 meltdown. (Long MCO, looking to get longer.)

* We constantly hear about price targets from WallStreet, not so much about “valuation”. Ultimately, you can put a dollar value on what a company is worth, and then look at the stock price, and see if the market valuation is at a premium or discount to your own valuation. It is an inexact science, but an “intrinsic value” is like a yellow light – it prevents investors from overstaying their position. There are still a lot of companies in our opinion, well below their intrinsic values in this market, including a lot of big banks, the old bubble babies of tech from the late 1990’s and more. Morningstar has some good research on “fair values” – these aren’t price targets either.

* For those investors in Cisco looking for some idea of the company’s longer-term growth rate, the answer this week came in the form of a increased dividend payout, which means the company is retaining less earnings for organic growth. Cisco today is the equivalent of a Rust Belt Industrial in the 1980’s and 1990’s: slow, stable, somewhat consistent, and somewhat dependable growth. (Long a little CSCO – not in a hurry to buy yet.)

* The answer to the stock market riddle over the next few weeks, will likely be found in the Treasury market. I still think higher interest rates are a plus for equities, and unlike Bill Gross, higher interest rates and a little inflation is a plus for the stock market. I think the Fed wants a little inflation, particularly in housing. Maybe not so much in corn, and the grain markets.

* We remain overweight industrials, technology and financials. It is difficult keeping up with this market – Google is up $100 just since their earnings report. It will be even more interesting to watch how telco’s and utilities perform if interest rates continue to rise.

* One of our industrial lemons the past year has been Fed-Ex (FDX). One of the great all-time brands, the stock has been trading around $90 (pretty much with spikes and selloffs intermittently) since late 2009. FDX will announce a restructuring of Fed-Ex Express before year-end. We like the stock here but be patient. Express is 2/3rd’s of FDX’s revenue but just 1/3rd of net income. FDX Ground is 25% of revenues and 50% – 60% of net income. Ground has really been hitting the ball out of the park for FDX. The Express restructuring could be the catalyst to ignite the stock if the economy starts to accelerate at the same time. We’d add to existing positions near $80.

I think there is a lot of retail money caught in the so-called “dividend trade” that is really more like a bond-proxy trade.

It wont be pretty, much like the corporate investment-grade crushing that will happen eventually. (Jeff Miller over at “A Dash of Insight” has guided investors how to prepare for the inevitable rate rise.)

Look for dividends with some underlying growth (like an Apple, or a GE, which will be a global industrial company more than a “financial in drag” when it completes its portfolio re-shuffling.) Don’t just buy dividend’s for dividends sake.

Thanks for stopping by,

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager





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