12.14.13: SP 500 Earnings Update: A Bet Against SP 500 Earnings in 2014, Will Be the Wrong Bet

Per ThomsonReuter’s “This Week in Earnings”, the forward 4-quarter estimate for the SP 500 rose $0.03 this week to $117.84, from $117.81.

The SP 500 p.e ratio on the forward estimate is 15(x).

The PEG ratio (SP 500 p.e-to-growth ratio) is now 1.88(x), as of 12/13/13, the lowest PEG ratio since March, 2012 !

The earnings yield on the SP 500 is 6.64%. (Think the 2.86% 10-year Treasury yield and think “Fed Model”.)

More importantly, the “forward 4-quarter” growth rate rose to 8.02% from last week’s 7.78%, for the first tick over 8% since January, 2012.

Despite the bubble-calling, and the negativity, the forward earnings growth rate is slowly ticking higher. This is very helpful to the market in terms of p.e expansion.

From a “market opinion” perspective, I still think we need a good flush, or correction of 5% – 10%, in the SP 500. And yet, Bespoke notes that AAII bullish market sentiment remains below 50% today, and hasn’t been above 50% since January, 2013, despite a near 30% return on the SP 500 for calendar 2013.

CNBC did a segment this week on Q4 ’13 earnings guidance, based on the following ThomsonReuter’s “This Week in Earnings” statement on guidance: “For q4 ’13 there have been 105 negative EPS preannouncements, issued by SP 500 corporations, compared to 10 positive EPS preannouncements. By dividing 105 by 10 one arrives at a N/P ratio of 10.5 for the SP 500 index. If this persists it will be the most negative guidance sentiment on record.”

The flaw or “catch” so to speak is that a lowering of guidance by a few cents from a previous range, constitutes one negative data point, which may or may not cause analysts to change their consensus estimate. (The other element to this is that if I went back and quoted previous quarters statements, you’d hear or see something similar written by ThomsonReuters, just not to the degree the 10.5 N/P ratio suggests. )

What CNBC or the segment didn’t say (I think) is that expected q4 ’13 SP 500 earnings growth of 7.8% is the strongest expected quarterly earnings growth in the last 2 years.

Retail investors don’t realize that companies issue forward guidance pretty consistently and yet, if you look at the ThomsonReuter’s consensus for the same period, the analyst consensus estimate is often different than the so-called mid-point of the management guidance, simply because analysts know when management’s are hedging and are being too bullish or bearish.  Thus there can be two different “estimates” for any company: management’s stated range or stated guidance, (and you average the range to find where management’s true EPS estimate resides) and then the sell-side analysts adjust that range for their own beliefs and their own bias’s (?) and arrive at their own consensus estimate, which may or may not be the same to where management guides the quarter or year.

A painful lesson learned the hard way about management guidance and forward estimates is Cisco (CSCO) and John Chamber’s guiding higher for the January, 2001 quarter in November, 2000, even though the stock price action and the estimates had begun to turn south. CSCO’s stock rallied for a few days and then rolled over. When Cisco and Chamber’s reported January quarter, 2001 results in early February 2001, the CSCO team guided lower, and the stock was done for good.

The November, 2000, CSCO conference call was a hallmark event in my education around company earnings and guidance, as was 2007 – 2008. It was a painful lesson learned.

The other element to this is that the N/P ratio is simply stated lower guidance, (the change could be $0.01 per share), which would constitute a negative data point, although the dollar estimate wouldn’t change very much.

So what’s the point ? The point is watch the “numbers” i.e the dollar estimate for the SP 500, and in particular watch the ThomsonReuter’s “forward 4-quarter” dollar estimate for the SP 500. Even the more aggressive dollar estimate for 2014 is looking for just $120 in SP 500 EPS in 2014, which given the $109.50 current estimate for the SP 500 in 2013 (which will likely end up over $110 when full-year 2013 results are all reported by April 1, ’14) thus the strongest growth being projected for the SP 500 in ’14 is just 10%.

q3 ’13 Earnings are Complete

Want to see an interesting statistic ? With 499 of the SP 500 having reported their q3 ’13 financial results, excluding JPM’s litigation charge, SP 500 have grown 8.5% year-over-year. That is much better y/y earnings growth than we’ve seen since q1 ’12.

Jeff Miller and Josh Brown (@ReformedBroker) have been publicly vetting the notion around SP 500 earnings that estimates start out too optimistic, then just before earnings are reported analysts as a whole become too pessimistic, and then actual results are “better-than-expected” which is why we see an upward drift to SP 500 earnings growth during reporting periods.

With q3 ’13 ACTUAL earnings growth at +8.5%, when did we last see this growth estimate when looking at back estimates for q3 ’13 ?

It was July 1, ’13.

Here is the history of actual and expected q3 ’13 SP 500 earnings growth:

12/13/13: +8.5% ( actual – operating eps, excludes JPM’s litigation charge)

10/1/13: +4.6% (est. – what is remarkable is that actual earnings have been stronger by almost 2(x) the original 10/1/13 estimate – that is a good sign)

7/1/13: +8.5% (est.)

4/1//13: +10.2% (est.)

1/1/13: +11.4% (est.)

3 – 6 months out is a good indicator of forward earnings for the quarterly numbers. Does that mean our “forward 4-quarter” estimate is too aggressive ? Could be, but they are different data points. ( I need to go back to prior quarters and look when actual EPS growth crossed the estimate and how far prior to the quarter that happened, but this takes time, and I want to hammer out the Weekend Earnings Update and enjoy the weekend. However, we will get to it at some point.)

The problem with this series is that we won’t know the full-year 2013 actual EPS estimate for the SP 500 until 4/1/13. It does put a crimp in the forecasting ability in terms of “certainty” or “probability” around the forecast.

Q4 ’13 Shaping UP Positively:

Expected earnings growth for the SP 500 for q4 ’13 is now +7.8%, down from 11% as of 10/1/13. We’re in the “shaving period” as we just proved with q3 ’13 numbers, but the key is we are entering q4 ’13 at the highest level of expected growth (+7.8%) in about 8 quarters.

On 10/1/13, we were expecting +4.6% for q3 ’13 and actual is +8.5%

A 7.8% estimate with just two full weeks left in the year and in q4 ’13 estimates, mean that on January 1, and just prior to the release of q4 ’13 earnings, we will be facing the highest y/y earnings growth estimates for the SP 500 since early 2012.

This is why we think that we will see +10% operating EPS growth for the SP 500 in q4 ’13, and the SP 500 has the ability to push higher from a total return perspective.

Even if the q4 ’13 SP 500 y/y growth estimate is cut to 5% for q4 ’13, the fact that q3 ’13’s actual EPS growth doubled from 10/10/13 to 12/13/13, tells me we could still get to 10% operating EPS for q4 ’13 when the majority of SP 500 companies have reported.

Basically, CNBC picked one data point in the ThomsonReuters “This Week in Earnings” missive and ran with it. They missed the other 10 others positive aspects to the SP 500 earnings data.

Gotta love the media…

Finally, PEG ratio History:

We noted near the opening paragraph that the SP 500 PEG ratio is now the lowest in 2 years. As forward earnings begin to accelerate, the market has now been flat on worries over taper, etc.

Here is the recent history of PEG, using the forward estimate, going back 2 years:

12/13/13: 1.88(x)

11/29/13: 2.03(x)

10/25/13: 2.23(x)

9/27/13: 2.09(x)

8/30/13: 1.98(x)

7/26/13: 2.23(x)

6/28/13: 2.59(x)

3/29/13: 2.40(x)

12/28/12: 2.55(x)

9/28/12: 4.18(x)

6/29/12: 2.80(x)

3/30/12: 1.87(x)

To be fair and even-handed about this data, in March, 2012, the SP 500 was on the cusp of an earnings slowdown, in fact q2, q3 and q4 ’12 were the slowest rates of y/y earnings growth for the SP 500 since the March ’09 market low.

But the SP 500 looked right through it, and the benchmark surprised a lot of investors by returning 15.98% in calendar 2012, despite the slowdown in earnings.

Could the opposite happen in 2014 ? Could SP 500 earnings grow 10% on the year, and the SP have a negative return ? It could, like in 1994, when SP 500 earnings grew 19% but the SP 500 was flat on the year given the 6 rate hikes, but I think we would need something else to happen, i.e. an exogenous shock, an heretofore, unseen inflation scare, that would shock or worry the Fed, and result in an unanticipated raising of short-term rates.

If we see more “stable” that would be a plus. The recent Budget deal in Congress between Paul Ryan and Patty Murray was a plus.

In terms of past market periods, I feel like we are in the 1991 – 1993 market period. The Fed really caused a shock in 1994 by raising rates 6 times, and I think that is the next shoe to drop, but ultimately, as 1994 proved, the near-term correction, set the stage for a longer-term rally. The 1992 – 1993 period followed the banking crisis of the late 1980’s (S&L fiasco) and the high yield liquidity crisis that took down Drexel. 1991, 1992, and 1993 was also the quiet period following the first Gulf War, when the large-caps were relatively subdued, but the Russell 2000 outperformed.

Growth is good, prosperity is good, jobs are good. Making money is good, as long as it is done honestly, ethically and legally.

Economically, I think the US economy is on the cusp of a period of decent economic growth that could last several years. Don’t forget too, 2014 is a mid-term election year.

We covered a lot of ground, with more to go. This was a longer post than we wanted.

Thanks for reading.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager




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