The commentary around S&P 500 earnings (both current earnings and future prospects for those earnings) from the media pundits is as bad as it gets, and yet I would speculate that more than a few folks were caught off guard by Friday’s late market rally, as the Dow 30 opened sharply lower but managed to slowly rally all day and finish the week close to the highs.
The S&P 500 was up a little over 1% on the week, while the Dow 30 rose a little shy of 1%, and the Nasdaq rose 1.78%. All three indices are nearing their April, May, multi-year highs.
A market or index that opens weak and finishes strong is a healthy market (in my opinion), and we saw that this week.
That being said, all 10 S&P 500 sectors and the major equity indices themselves are overbought and in need of a correction.
According to ThomsonReuters, the “forward 4-quarter” earnings estimate for the S&P 500 as of Friday night was $108.17, down $0.06 from the prior week’s $108.23. The recent all-time high for the forward estimate was the week of July 13th, where we saw a $111.88 estimate and the recent low for the key metric was $105.56 back on March 30th.
Despite the rhetoric and pessimism, as you can see from the numbers, the forward estimate for the S&P 500 continues to hold in pretty well, although no question year-over-year growth has slowed the last 12 months. Since mid-July too, the earnings beat rates for both top and bottom line look better.
We are out on a limb here, but my personal opinion is that S&P 500 earnings will trough with the 3rd quarter, 2012 results, and we will see better earnings growth in q4 ’12 and beyond, part of the prediction being based on the fact that once the Presidential election is out of the way, and the make-up of Congress is decided, the fiscal cliff and the Bush tax cuts, not to mention the payroll tax issues, will get dealt with, and quickly.
However, back to earnings: with this week’s reports which includes Home Depot (HD), Cisco (CSCO), WalMart (WMT), Applied Materials (AMAT) and John Deere (DE) (amongst others), earnings season will come to an unofficial end. Per ThomsonReuters, as of Friday, August 10th, 445 of the 500 S&P 500 companies have reported 2nd quarter earnings. The earnings beat rate is 68%, about in line or slightly better than historical averages, while the revenue beat rate is just 41%, far below the 2/3rd’s beat typically seen. (Check www.seekingalpha.com for our earnings previews.) Home Depot’s is up already, while Cisco, WalMart and Applied Materials will follow shortly. (Long AMAT, WMT, and HD, and DE, CSCO in smaller percentages.)
While the revenue beat is an issue, part of this is due to currency, and as we wrote last week, the fact that companies can miss on the top-line, and yet still make eps numbers, implies quite a bit of financial flexibility, probably more than a little of this coming from the prodigious cash-flow of Corporate America today, which implies that corporations may be buying back more stock or accelerating the stock repurchase program. (That is a guess – I don’t have hard data on that. The other educated guess is this is one plausible reason our job growth off the recession bottom being so far below trend. Corporations are milking productivity and not hiring until they are more confident about what the future holds in terms of tax and regulation.)
We’ll leave readers with one final earnings metric from ThomsonReuters, and is part and parcel to our prediction that S&P 500 earnings will bottom in the 3rd quarter, 2012.
Actual and estimated S&P 500 earnings growth by quarter:
q2 ’13 +10.5% (current expected growth rate per consensus)
q1 ’13 +7.1% (current expected growth rate per consensus)
q4 ’12 +10.6% (current expected growth rate per consensus)
q3 ’12 -1.6% (current expected growth rate per consensus – first negative qtr since mid ’09)
q2 ’12 +8.4% (almost in the books. Ex out financials, “true” growth rate closer to 1%)
q1 ’12 +8.1% (actual – remove Apple, and closer to 5%)
q4 ’11 +9.2% (actual)
q3 ’11 +18% (actual)
q2 ’11 +12.1% (actual)
q1 ’11 +18.9% (actual)
Most of our valuation models assume a 7% long-term earnings growth rate for the S&P 500, and the fact is actual earnings growth off the March ’09 bottom for the S&P 500 has been WELL above 7%. It is only the last two quarters and mid 2012 that we have seen mid-single digit and the negative forecast.
One major caveat: most of these “forward” quarterly estimates have been on a downward trek. In other words, forward growth is being revised lower (still). Those growth estimates you see for forward quarters are as of Friday, August 10th.
Despite record pessimism and market sentiment, the stock market marches forward. My personal inclination is to be wildly bullish but it would be treated as lunacy, almost as if someone who had come on CNBC in March of 2000 and said that the Nasdaq will correct 80%, Fed easing in 2001 and 2002 would not work, we are headed for a decade of true deflation, and gold will outperform all other asset classes (except bonds) in the next 10 years. (How crazy would that prediction have been ?)
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Trading / market update:
Our sector overweights remain Industrials, Technology and Financials. Nothing has really changed. We still REALLY like industrials, as a sector. Great cash-flow, good dividends, modest valuations (thanks primarily to European exposure) and little to no interest. Nothing sexy about Industrial America. However, estimated q3 ’12 earnings growth for Industrials has been reduced from 10.1% on July 1 to 5.7% as of August 10th.
The only two sectors that have seen their q2 ’12 earnings growth rates revised lower (following actual earnings reports) since July 1 are Energy and Basic Materials, every other sector is higher since July 1.
* Coca-Cola split their stock 2-for-1 on Friday August 10th. I still think the stock makes an all-time high before year-end, 2012. That would be a trade over $88.94 (pre-split) on August 5th, 1998. It has been 14 years since KO has made an all-time high. Just for grins, we looked at our KO valuation spreadsheet and in 1998, KO earned $1.42 per share on $18.8 bl in revenues. Today, or in 2012, KO is expected to earn a little over $4 per share on roughly $48.6 bl in revenues. Coca-Cola earnings and revenues are up over 200% in 12 years, and the stock still has a negative return (excluding dividends); (long KO, want to get longer)
* Is buy-and-hold dead ? Richard Bernstein of Richard Bernstein Advisers doesn’t think so and neither do we. We’ve had one client since 1997 – very sharp woman – with a good sized portfolio and she doesn’t like capital gains taxes. She emphatically told me that if i had sold all of our large-cap tech exposure in March, 2000, she would have fired me. While we trade other’s accounts, we tend to sit on positions in this client’s account. Very low turnover – guess which client has pretty decent relative performance to the S&P 500 ? Yes, that client. We are still ahead of the S&P 500 by a smidge since July 31, 1997, on this client’s taxable account. Buy-and-hold still works;
* Europe – after two years, now we are seeing the earnings impact from Europe, Ford (F), Priceline (PCLN), etc.. Up till mid, 2012, Europe, despite the headlines, has been minimal impact on S&P 500 companies. Maybe this will spur Draghi and Merkel to make real progress. After the China export numbers Thursday night, can’t believe China isn’t paying Europe for a resolution. (Long F)
* Natural gas – attended two lunches in the past two weeks, one sponsored by the American Gas Association, and the other a brokerage luncheon. When queried, two independent sources said that the “equilibrium price” of natural gas is “$4 to $6” per bcf (AGA), and the brokerage analyst said “$4.50 to $6.50”. Natty gas rally still has a ways to go. We are underweight energy, but long some nat gas equities;
* Microsoft’s cash hoard: MSFT has $64 bl in cash on the balance sheet as of June 30, ’12. The prior peak was $64 bl in Sept ’04 just prior to their special dividend, which they declared or announced in the summer of ’04 I believe. They won’t do it again though, which is a sentiment they have expressed publicly. Inefficient use of capital they said. The key thing is 85% of today’s $64 billion is held or custodied overseas. Congress, are you listening ? (long MSFT)
* Ed Hyman, brilliant economist from ISI Group, and a great firm to boot: From ISI Group research, Ed notes that $40 BILLION has left equity mutual funds this year alone (year-to-date). I dont have the investment grade bond fund inflow data. Contrarian signal anyone ?
* A bunch of department stores (even JC Penney’s, the latest whipping boy) reported earnings this week, and all traded better except Kohl’s (KSS). July comp’s – for the most part – looked pretty good. Back-to-school (BTS) season is clouded with pessimism – will this be wrong as well ?
* Finally two thoughts on interest rates and credit: Jeff Kilburg, a CME technician and frequent CNBC commentator was on the fat box this week, and said that two consecutive closes for the 10-year Treasury above 1.71% and he’d short the 10-year Treasury. His calls have been accurate – last fall he said the 10-year Treasury would re-test the Late September – early October, 2011 lows near 1.60%, sometime in 2012. He was right. (long TBF, TBT)
* Regarding credit, Moody’s said that the trailing 12-month global speculative default rate as of June 30 was 2.7%. Both the HYG and JNK high yield ETF’s yield better than 7% – well above the default rate. What worries me is that i continue to hear a litany of CNBC guests come on the fat box and say “they like high yield” or “high yield is safe”. It is almost universal now, kind of like the death of equities. Still, the S&P 500 and the corporate high yield bond markets are pretty tightly correlated. See last week’s post on other credit / high yield thoughts (if you want). (Long JNK, HYG, and two open-ended mutual funds as well, PIMCO and Pioneer);
* Basic materials names like Alcoa, Freeport and BTU got a bid this week. Charts starting to perk up (long only Alcoa or AA).
* Finally, we’ll conclude with the comment that I’ve never seen a market where so many stocks across so many sectors look as attractively valued as they do today, particularly mega-cap, large-cap and large-cap growth. Cash-flow valuations in many cases are better than p/e valuations. Large-cap industrial, large and mega-cap tech, large-cap pharma, and large-cap financial, all with lower p/e’s than the S&P 500, better dividend yields, and better expected growth.
Still, the charts are overbought – would love to see a 5% correction.
Thanks for stopping by:
Trinity Asset Management, Inc. by:
Brian Gilmartin, CFA
Portfolio manager