Per ThomsonReuters, the “forward 4-quarter” earnings estimate for the S&P 500 as of Friday, October 12th was $111.85, still a record estimate for the S&P 500 but lower than last week’s $112.26.
The recent low in March, 2012 of $105 has not been breached, and the July 13th high of $111.88 continues to be a tough level to penetrate.
Forward earnings estimates have been locked in this range for some time, since late July of 2011, but stabilizing near record levels. In order for the S&P 500 to break out to record highs, above the March, 2000 and October ’07 highs at 1,550 and 1,575, I think we need to see that forward estimate break free of this $111 – $112 congestion and start to move towards $120.
How likely is that to happen ? Well, as we alluded to last week, the forward earnings estimate has started to reflect year-over-year growth again, which is a good sign.
Each week, we like to leave readers with some earnings data that allow the reader to draw their own conclusion rather than having a market premise and then wrapping the data to fit the outlook. Here is a long term look at the “forward 4-quarter” eps estimate for the S&P 500 as of July 2011, to the current week. Note the estimate and year-over-growth number: (The first column is the week ending date, the 2nd column is the S&P500 forward estimate, the third column is the year-over-year growth rate.)
10/12/12 $111.85 4.91%
9/28/12 $107.39 3.20%
9/14/12 $107.84 2.36%
8/31/12 $108.02 1.92%
8/17/12 $108.07 1.39%
8/3/12 $108.23 1.08%
7/28/12 $109.01 1.77%
6/29/12 $107.25 4.53%
5/25/12 $108.75 6.51%
4/27/12 $109.74 5.92%
3/30/12 – $105.67 7.13%
2/24/12 $105.68 7.45%
1/27/12 $106.10 7.84%
12/30/11 $103.33 10.75%
11/25/11 $104.39 11.89%
10/28/11 $104.98 12.32%
9/30/11 $104.44 16.02%
8/26/11 $106.20 16.71%
7/29/11 $107.08 17.35%
What should quickly become obvious to the reader is that from July, 2011 to July, 2012, while the absolute dollar estimate remained relatively stable between $105 and $110, the year-over-year earnings growth for the S&P 500 showed gradually slowing year-over-year earnings growth, up until that first week of August, 2012, when the year-over-year numbers started to tick higher. When did the S&P 500 bottom in terms of its summer correction in 2012 ? The last week of July. (If I had more time, we could put this data on an Excel spreadsheet and show the trends in way that would be more visually appealing. However simply follow the 2nd and 3rd columns and you’ll get the idea of what we are trying to show.)
To his credit, my friend Jeff Miller over at “A Dash of Insight”, was writing in the 3rd quarter of 2011, amidst all the US credit rating downgrade and European turmoil, that ECRI’s forecast for a recession were incorrect and that it was highly likely that the US economy wouldn’t see a recession. I wonder now, with the benefit of hindsight if the S&P 500 market action in the 3rd quarter of 2011, wasn’t just a reaction to expectations of slower earnings growth ahead, just like the market rally that has caught everyone off guard since late July ’12 could be discounting stronger earnings growth ahead.
So far this year, the stock market is demonstrating its typical Presidential year trading pattern, but the S&P 500 earnings data is supporting that market pattern as well.
Bespoke noted in its 10/12 Week In Review that “bullish sentiment amongst individual investors is much closer to its lows of the past four years than its highs, even though the stock market is at four-year highs.”
If the pattern holds, we would expect the S&P 500 to bottom here shortly, even though “market calls” are not our forte’. The S&P 500 is testing its 50-day moving average. The flood of 3rd quarter, ’12 earnings start this week on Tuesday morning. We expect the quarter’s results to come in better than expected. More to follow in our market / trading update.
The other aspect to the above data, is the P/E being assigned to those earnings. We have yet to see a market where the P/E for the S&P 500 expands. The S&P 500 p/e has been locked in a range between 11(x) – 13(x) those forward earnings for about 18 months.
To conclude, S&P 500 earnings are not the issue, and we continue to expect q3 ’12 to be the nadir for the post-recession earnings boom, and begin to grow year-over-year once again, in the 4th quarter, 2012 and into 2013.
Trading / Market update: we prefer to keep S&P 500 earnings analysis separate from the sector / stock / bond market observations so readers can digest what is usually an incredible amount of math and detail, in an easy fashion.
* Energy was the best performing S&P 500 sector in q3 ’12 and naturally we were underweight it. As of the 3rd quarter, the 4 sectors with better than 20% returns were technology, telco, financials and consumer staples (thanks to housing I would guess).
* We remain overweight technology, financials and industrials in client accounts. Industrials have been some of the punk performers year-to-date, like Boeing (BA), United Technologies (UTX), Deere (DE), Fed-Ex (FDX), which saw a nice pop this week. (Long all those just mentioned.) Apple has really helped technology, and we think financials are in the earler stages of a longer move. (long AAPL, and a bunch of financials.)
* One of our better sector bets this year has been healthcare, particularly large-cap pharma, like Pfizer (PFE), Merck (MRK), Amgen and Johnson & Johnson (JNJ). We think Dr. Mark Schoenebaum of ISI is the one of the top sector analysts and John Mendelson (the ISI technician) was early and right in terms of the technicals. Mark made an interesting comment in one of his recent video’s on the large-cap pharma sector: Mark thinks the sector could see a “p/e re-valuation” to the upside if the Phase 3 pipelines just meet their typical 40% – 70% success rates for Phase 3 drugs. Mark’s contention all along is that the large-cap pharma pipelines (at least when PFE was trading under $20 and Merck under $40) was that the pipelines were being valued at almost a 0% success rate, or no value was being assigned to them at all. The relative strength of large-cap pharma continues to impress. Even though the stock market has pulled back the last few weeks, PFE, MRK and other large-cap pharma continue to trade well on days with a bad tape, much like housing stocks. Waiting on a pullback is like waiting on Godot. (Long PFE, MRK, AMGN, JNJ)
* Worst trades this year ? Selling Google at $570, and Verizon at $38. (Run, Brian, Run, to quote Forrest Gump.) AT&T, at least according to Bespoke, is now trading 3 standard deviations below its 50-day moving average, which probably means it could be ripe for a bounce. Looking at our internal chart for “T”, it is getting oversold, but it has come off its highs quickly after falling below its 50 day moving average. Something does not look right. We’d prefer to buy closer to $34 which is the uptrend line off the 2011 and 2012 lows. Even more, I would prefer to see what T’s earnings look like. The telco’s look like a crowded trade. The telco’s pay out a substantial amount of their earnings in the form of dividends; T’s payout ratio is nporth of 60%, while Verizon’s payout ratio os north of 80%, which could be influenced by Vodafone and the minority stake in Verizon Wireless. (Long some GOOG, T)
However, when we run operating cash-flow per share (OCFp/s) on our spreadsheet, and free-cash-flow per share (FCFp/s) for T, the dividend payout ratio is still 60% of T’s free-cash-flow per share.
We just started modeling both telco’s, but my guess is – given the dividend – I wonder how much stock both telco’s are repurchasing.
AT&T is a lot more oversold here than Verizon. It is just our opinion, but i think you want to trade both telco’s rather than become permanently attached to them.
* Is the corporate high-yield (i.e. junk bond market) now a bubble ? We’re getting to hate that word, “bubble” because everyone now uses it, but is high-yield becoming a crowded trade ? Spreads are pretty tight, annual defaults are now below 2% and there seems to be a flood of money coming into the asset class. Gary Komensky was on CNBC this week sounding the alarm on the corporate high-yield asset class. If you are a top-gun portfolio manager, and you want to retire with a cush job, befriend someone on CNBC, and then turn in your trading turret for a microphone on the fat box, and live the easy life as many seem to do. Gary has moved from an investor to market commentator (to my knowledge), but that doesn’t mean he is wrong – its just means he now has a much bigger audience. We too are starting to worry about high yield: portfolio manager after portfolio manager is starting to look at high-yield as a safe haven as they reach for yield. I worry that the Fiscal Cliff (or whatever is left of it after the election) could impact interest income adversely, not just cap gains. These markets never unravel as you think. Interesting quite from Moody’s Credit Outlook weekly update last week, “September’s US high yield issuance surge was accompanied by the 4th weakest level of average covenant quality that we have seen since we started scoring in Jan, 2011. The average covenant quality score for high-yield bonds issued in September was 3.88 on our scale, where 1.0 is the strongest and 5.0 is the weakest.”
Granted, Moody’s history is n0t that long – almost 21 months – but it is quantifiable. We are overweight high yield with a 20% – 30% allocation in balanced and fixed-income accounts.
We think a lot depends on the strength of any economic acceleration post-election. However we are very cognizant of the fact that the high yield asset class is now in the process of tilting from more reward to more risk.
* Morningstar mutual fund data released this week: another $30 billion went into bond funds (Double-Line and PIMCO) and $17 billion left equity funds in September. Smart-money, dumb-money or something in between ?
* The last comment of the day: Technology stocks – just 29% of the tech sector is trading above its 50-day moving average as of Friday, October 12th per Bespoke. We wrote on this blog the last few weeks that the PC sector is trading for scrap value, which we believe it is. As i finished my workday on Friday, October 12th, and caught the beginning of Mad Money with Jim Cramer, it was noted that in talking about earnings this coming week, he didn’t even bother to mention Intel’s q3 ’12 release this Tuesday night (to my knowledge). Although it is a topic for another time, I think there is a certain mad genius to Jim and his investing style (no pun intended) but i think he is emblamatic of the negative sentiment surrounding the PC sector specifically and the tech sector in general. I have no idea what Intel will say Tuesday night but at 5(x) – 6(x) cash-flow, the stock is good for a trade (at least) and a longer-term buy-and-hold at best. It will run back to the high $20’s at some point, and technically isn’t broken.
* Walmart had their annual analyst hoedown in Arkansas this week. Same day delivery is now the rage in retail. Have to believe UPS and FDX benefit from what should be a whole new flow of business ? Walmart (WMT) saw a surge in volume with the analyst day, and saw a close above $75 this week, which is thought to be a short-term breakout. In our opinion WMT is the most mis-understood company in America, thanks to the beating it takes. What an incredible success story and now America’s single largest employer. Just like the mid-1990’s, WMT’s stock took off amd coincided with the improvement in their US comp’s. (long WMT, FDX.)
This week was a long missive. Much to say, hopefully you found it interesting.
Thanks for stopping by.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA