A wise person once counseled that no one can have all the right answers, but you can ask the right questions, and this week I thought that the right question was, “Can we have some meaningful deficit reduction, without driving the US economy into recession ?”
If someone shouts “Fiscal Cliff” one more time this weekend, I think I am going to step right in front of a Chicago bus. Now that the election is over, and there aren’t 35 different polls to report on, each with their own statistical nuance, the cacophony heard daily on the financial news is now all about ‘The Cliff” and impending doom, and ‘Rise Above” and we’re all going to hell, and don’t just be afraid, but be very afraid.
Barron’s reports this weekend that now the US economy is SURELY headed into recession in early 2013.
As my friend Jeff Miller wrote a few months ago on one of the best blogs written every weekend (i.e. A Dash of Insight), “occasionally something goes right”. (http://oldprof.typepad.com/) Here is Jeff’s latest from last week on debunking the recession myth.
This week, ThomsonReuter’s reports that the “forward 4-quarter” earnings estimate for the S&P 500 is $109.90, which is down $0.68 from last week’s $110.58 and down almost $2 in just the last three weeks. We dont know how much of that is Sandy and how much is normal operations. With the S&P 500 closing at 1,379 on Friday, November 9th, the market P/E ratio is 12.5(x) that forward estimate, with S&P 500 earnings expected to grow 4% for full-year 2012 and 11% in full-year 2013.
The S&P 500 earnings yield as of Friday’s close was 7.96% – getting close to the record highs from early July of 8.25%. (If you are a believer in the Fed Model, then the S&P 500 earnings yield is significant, particularly when the 10-year Treasury is trading at 1.61%.)
I’ll take a pat on the back this weekend as even ThomsonReuters grudgingly came around to our view that 3rd quarter, 2012 will be the nadir for S&P 500 earnings growth, with this sentence on page 2 of their excellent weekly missive “This Week in Earnings”, “But even with the negative outlooks by company management teams and analysts, it appears that the 3rd quarter will be the trough in earnings and that positive growth will continue over the next year.”
We’ve been saying this for a quite a while.
For the 3rd quarter, 2012, as of Friday, November 9th, the S&P 500 year-over-year earnings growth is -0.2% and y/y revenue growth is -0.7%. Both stats have improved since the quarter started.
For our “stat of the week” here is how forward quarters currently look in terms of S&P 500 earnings growth from q4 ’12 – q3 ’13, both as of Friday, Nov 9th (first column) and as of July 1 (2nd column):
q4 ’12 +5.6% +13.9%
q1 ’13 +5.1% +8.6%
q2 ’13 +9.1% +14.4%
q3 ’13 11.9% +15.9% (as of Oct 1)
2013 (full year) +10.9% +12.4%
While forward estimates are still getting trimmed, the fact is there is still going to be year-over-year earnings growth. We’ve been tracking this data forever, (since 2000) and my guess is that q4 ’12 and q1 ’13 will be low to mid-single-digit earnings growth for the S&P 500, with q1 ’13 stronger than q4 ’12, and q4 ’12 stronger than q3 ’12, and then we ramp gradually as we move through 2013.
The fact is the S&P 500 is still pretty reasonably valued, and pessimism is rampant.
Here is just a quick rundown of the S&P 500’s key valuation metrics:
P/E ratio – 12.5(x) (forward p.e as of this weekend)
Price to cash-flow 9(x) – as of 9/30
Price to book – 2.3(x) as of 9/30
Price to sales – 1.3(x) as of 9/30
PEG (p/e to growth) – 1.63(x) as of this weekend, averaging 2012 and 2013’s expected earnings growth
Dividend yield – 2.3(x) as of 9/30
Earnings yield – 7.96% as of 11/9
The source of some of this data was JP Morgan’s Guide to the Markets, published every quarter. What is even more interesting is that on Sept 30th, the S&P 500 closed the 3rd quarter at 1,440 or 60 points higher than Friday’s close, so some of those valuation metrics cited as of 9/30 look better today.
Finally, Brian Wesbury had a great valuation piece published on Monday, 11/5 http://www.ftportfolios.com/Commentary/EconomicResearch/2012/11/5/election-matters,-but-stocks-are-cheap if you can take a minute to read through it.
Trading / sector / market comments November 10th, 2012:
* The S&P 500 closed Friday, just underneath its 200-day moving average. The uptrend line off the 2008 – 2009 recession low comes into play right around 1,350. There should be good support for the S&P 500 between the 200-day moving average and 1,350.
* Wow, did financials get hammered on Wednesday, possibly thanks to the Democratic sweep of the Senate, and the Presidency, and possibly due to Elizabeth Warren winning the Massachusetts Senate seat from Scott Brown. Ms. Warren is a virulent regulationist and a big-bank “hater”. Ironically, financial sector earnings estimates have been gradually improving since July 1, the only sector to do so, with regularity. What I found even more interesting is that when Maria Bartiromo interviewed JP Morgan’s CEO, Jamie Dimon, on Thursday or Friday on CNBC, one of the first things he said was he would reach out to Ms. Warren and extend an olive branch. She will undoubtedly end up on one of the Senate Banking Committee’s and could make life miserable for the banking industry. The Boyzz better be prepared to come to Ms. Warren on bended knee, else they are apt to become the next public utilities.
* We thought financials – given the gradually improving earnings estimates – could be a safe haven for this market. Wednesday was a wake-up call. Jim Cramer wrote (or said) he thought Ms. Warren’s intent might be misconstrued. I sure hope so.
* Two favorable signs we saw in the financial sector Thursday and Friday: although it wasn’t expected until q1 ’13, JP Morgan (JPM) received permission to re-start their share repurchase program in the 4th quarter. I think that came from the Fed, or one its branches, but it could have been in response to Wednesday’s price action in financials. Either way, it was a good sign. Even further, it was read on Friday that Basel III capital standards would be implemented more gradually than was originallty thought, which is another positive sign that the regulators are NOT trying to choke off and over-regulate the financial sector and render it impotent.
* Dimon said in his CNBC interview that JPM would love to buy shares back at below tangible book value, which we figure is closer to $35 per share, and which consensus analysts estimate to be $37.50. I can’t tell if that means Jamie doesn’t think the buyback is a good spend with the stock at $40 or if he thinks tangible book value is higher than $35. Either way, JPM is expected to earn $5.00 per share in 2012 (actually $5.02 per share and up 12% in terms of eps growth), even with the earnings hit this year that was the London Whale fiasco. The stock is still cheap and one of our larger financial holdings for clients. (Long JPM…)
* Bespoke noted this week that just 25% of the S&P 500 is trading above its 50-day moving average. That is well off the 75% highs hit late September. The sectors that have suffered the worst are technology, (20% above 50 dma), utilities (0% above 50 dma), telecom (25% of stocks above their 50- dma) and staples (24% of the sector above their 50 dma). Way ugly in terms of the damage. We think the stock market is nearing a bottom though.
* The bond proxies like staples, the dividend trade, and higher dividend-yielding stocks have been hit pretty hard. It was just a matter of time before that happened though – talk about a crowded trade. Look at Altria (MO) – the US portion of the Philip Morris. Pretty oversold here. The risk here for the dividend trade is that dividend income starts getting taxed at “ordinary income” rates in 2013. I suspect -if that happens – it will push a lot of companies into more share repurchase programs than dividend programs. (No positions in MO).
* Ironically, Industrials is the one sector where 50% of the sector is still trading above its 50 dma, probably because the sector has been lagging the S&P 500 for a while. This is one of our sector overweights and offers great long-term value in our opinion, but you need to be an investor, not a trader. It could be that industrials dont catch a tailwind until mid 2013, if then, depending on how fast China can accelerate and if Europe can just stabilize. We like Boeing (BA) and United Technologies (UTX) and we are looking hard at the other defense stocks although we sold Lockheed Martin (LMT) this week after Wednesday. It was a small position. (Long BA, UTX, DE, and a host of others).
* Starbuck’s (SBUX) held in very well this week, after their 10% rally off their earnings report the prior week. No give-back there at all. We still like Sandisk (SNDK) too, the NAND flash memory maker. Earnings estimates have been increasing for both companies. (Long SBUX and SNDK – trying to add on weakness)
* This week we hear from more technology and retail companies: we hear from the Pc sector with Dell and Hewlett (HPQ) and we hear from WalMart (WMT) on Thursday before the bell. Home Depot (HD) and Cisco report Tuesday, WalMart (WMT), Applied Materials (AMAT), Dell (DELL) and Target (TGT) report Thursday. The Pc sector is – in our opinion – trading for scrap value. DELL looks to be a better value here than Hewlett. We’ve been loyal buyers of DELL PC’s since the mid 1990’s and the last couple have been total crap in terms of breaking down. (I am writing this on a Dell PC with a defective AMD driver that necessitates that i save this blog post every 30 seconds or so, so I dont lose it. Very frustating, but I hesitate to buy a new one or try HPQ given the state of the business right now.) (Long WMT, HD, and AMAT)
* Here is our SeekingAlpha preview of Home Depot http://seekingalpha.com/article/982711-home-depot-earnings-preview-expense-discipline-has-been-phenomenal-need-to-see-comp-growth. The fascinating aspect to Home Depot is that they havent been opening any new stores the last 3 years – they’ve generated prodigious cash-flow simply by being a better operator. Kudo’s to them. I would love to see some comp and revenue growth though as the housing recovery gathers strength.
* The PC sector is trading like the gold sector or basic materials did in the 1990’s – unwanted, unloved, and deep value. If you venture into DELL or INTC, you need to be patient.
* Lastly, a Portfolio manager friend who now tweets regularly with good information: Norm Conley of JA Glynn out of St. Louis tweeted this, this week, on bank loans http://twileshare.com/xns. Bodes well economically – market is too pessimistic here ?
Thanks for reading – we covered a lot of ground this week, and could have written for another hour or two. Comments and criticisms welcome.
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager