Market update – Sept 15th, 2012: Corporate earnings unchanged – is it time for P/E expansion ?

Originally, this blog was intended to be dedicated to commentary and analysis of corporate earnings, particularly S&P 500 earnings, as detailed by ThomsonReuters, but in fact – in times like the last few weeks, and probably until mid-October – the outlook for S&P 500 earnings will remain pretty much unchanged and the commentary regarding earnings (I’m guessing) will be very similar to what you’ve read the last few weeks, thus there isnt much to add.

497 of the S&P 500 companies have reported 2nd quarter, 2012 earnings, with year-over-year growth (y/y) around +1.5% when financials and Bank of America are excluded (due to easy comparisons from q2 ’11). This is the lowest rate of y/y growth for the S&P 500 since the March, 2009 market bottom. Revenue growth for q2 ’12 is coming in at +1% y/y.

For q3 ’12, y/y growth in earnings is projected to be -2.2% and revenue growth is expected to come in at -1%. These numbers have been essentially unchanged for the last 4 – 6 weeks. This expected -2.2% y/y decline represents the lowest rate of growth for the S&P 500 since late 2008, early 2009.

For q4 ’12, y/y growth in S&P 500 earnings is expected at 10%, and if earnings come in at this level or better, it will be the fastest rate of growth for any quarter in 2012.

This week, the “forward 4-quarter estimate” for the S&P 500 fell to $107.84 from last week’s $108.02. This slow drip lower will likely continue until October 1, when we expect to see the typical jump in the forward 4-quarter eps number as the new quarter starts.

Full-year 2012 and 2013 S&P 500 earnings growth is expected at 6.1% and 11.8% respectively.

For the past two – three weeks, we have had a dearth of S&P 500 companies reporting earnings. This week that changes with Fed-Ex (FDX) reporting before the bell on Tuesday morning, Bed, Bath & Beyond (BBBY) reports Wednesday, and finally Oracle (ORCL) on Thursday after the bell. (Long FDX and small amount of ORCL – see more below.) With these reports, we see the financial results of a major transportation company / industrial, a housing-based retailer, and an enterprise software company, which is a pretty good cross section of the economy, from both a consumer and large-company perspective.

Each week, we like to leave readers with a statistic (or statistics) that might provide some perspective to the cacophony of babble that is heard daily / weekly in the financial press. Because so many of the quarterly numbers can be influenced by shorter-term events like writedowns and currency, we like to look at the full-year trends in estimates by sector. The following is the 10 sectors of the S&P 500 earnings growth estimates for 2012, as of July 1, and then as of Friday, Sept 14th. 2013 estimates follow below:


Cons disc: 11.6% and 10.5%

Cons stpl: 6.4% and 4.3%

Energy: -5.7% and -9.9%

Fincls: 24% and 23.2%

Hlth Care: 2.2% and 2.2%

Industrials: 9.9% and 9.8%

Materials: -0.7% and -7.8%

Technology: 7.1% and 9.5%

Telecom: -0.9% and -1.6%

Utilities: -7.8% and -7.3%

S&P 500: 6.3% and 6.1%

Since July 1 (first column) for full year 2012, 6 of the 10 sectors of the S&P 500 have remained relatively flat from an earnings growth expectations perspective: Consumer Discretionary, Financials, Healthcare, Industrials, Telecom and Utilities. Three sectors have seen sharp downward revisions either in absolute or relative terms: Consumer staples (probably currency), Energy, and Materials. Only one sector has seen an UPWARD revision in growth expectations: Technology. (Could be largely due to Apple.)

2013 estimates (first column is July 1, and the 2nd column is earnings growth expected as of 9/14):

Cons disc: 16.5% and 15.5%

Cons stpl: 8% and 9.4% (housing boom, anyone ?)

Energy: 10% and 8.5%

Financials: 15.1% and 12.4%

Hlthcare: 7.7% and 8.9% (large-cap pharma and biotech ?)

Industrials: 12.8% and 11.5%

Materials: 19% and 23% (maybe the latest rally in materials makes sense…)

Technology: 13.9% and 13.2%

Telecom: 17.5% and 22.5%

Utilities: 3.4% and 2.4%

S&P 500: 12.4% and 11.8%

Relative to estimates, the 13(x) forward multiple on the S&P 500 today doesn’t look too salty, but we should only give credence to the year-end 2013 estimate once q4 ’12 financial results start to get reported in January ’13, since it is at that time that corporate managements start talking full-year guidance. Not all managements will give full-year guidance, but enough will do so so that a full-year estimate mosaic can be reasonably formed. Given the Presidential election this year, and expectations over Congressional elections, the 2013 guidance we start to hear in January will take on particularly heavy importance. As of Friday, consumer staples, healthcare, telecom and materials have seen expectations raised for 2013, since July 1. Materials is the big positive change for 2013, relative to 2012. Note how energy is still declining.

These estimates change weekly and in some cases daily. My own thoughts are that – depending on the election – earnings growth is still being underestimated for this year and next. There is little incentive for managements or analysts to be aggressive these days, very much unlike the 1999 – 2000 period.

Also, remember, we’ve been through 12 years of p/e contraction for the S&P 500. Expect the naysayers to be out full force, when we go through the early phases of p.e expansion as we could be seeing currently.

Stock/sector/asset class/market commentary:

* We wrote an article this week for Seeking Alpha detailing our analysis of Intel We were also buying the stock this week. 6(x) cash flow is attractive, and we think fair value is roughly the $30 neighborhood. We were also buying Coca-Cola (KO) this week as we look around for technically-oversold names that might have some catalyst. Jim Cramer had an excellent point on Squawk Box on Friday morning when he mentioned the dollar weakness, and that analysts would likely take numbers up for KO for q3 ’12. (80% of KO’s operating income is non – US, so KO is a weak dollar beneficiary.) Im not sure about Jim’s comments specifically regarding KO, but recall the dollar was strong in q2 and now weak again in q3, so some of this weakness in the “defensive’s” like tobacco, pharma, etc. might see a currency boost with the q3 ’12 earnings releases. The weak dollar in q3 ’12 which has now given up most of its 2012 gains, might be enough to push earnings and revenue growth to positive numbers for q3 ’12. (Long INTC, KO, large-cap pharma, etc.)

* Treasuries were beaten-down this week, as the 10-year yield rose from 1.66% to 1.87%. The 10-year Treasury yield is just back to its early May levels but more importantly the “yield” chart is now hitting its 200-day moving average. The late fall 2011 high for the 10-year Treasury was 2.40% – it is that level where i think you can put a fork in the 30-year Treasury rally.

* Late July was the tipping point for the S&P 500 and Treasuries: in another year we might look back at that 1.38% low yield on the 10-year Treasury much like 5,000 on the Nasdaq in March of 2000. Great call by ISI Group and their research staff. They caught the disconnect for the S&P 500, as it broke with the 2010 and 2011 patterns, almost to the day, in late July. Very astute and very value-added research. John Mendelson, ISI’s crack technician, also raised the red flag on the 10-year Treasury’s technicals this week. Another great call, from a rock-solid shop.

* The S&P 500 remains pretty overbought, except utilities. Per Bespoke, the following is the percentage of stocks in each sector trading above their 50-day moving averages (as of Friday):

* consumer discretionary – 86%

* Consumer staples – 71%

* Energy – 96%

* Financials – 95%

* Industrials – 87%

* Healthcare – 83%

* Materials – 90%

Technology – 87%

Telecom – 100% (note that AT&T and Verizon were weak last week. T had a negative return for the week, despite Apple’s iPhone 5 launch and the market rally.) Long AAPL, small T position

Utilities – 32%

The S&P 500 could be thought to be stretched here as has been the case for the last 4 – 6 weeks.

* FedEX (FDX) reports Tuesday morning and it has been one of our industrial “dogs” for a while. Still we love the brand and the company. Here is our earnings preview as written for Seeking Alpha this week. Expect FDX  to restructure Express when the analyst conference is held in October, but management might give some hints as to what they expect to do Tuesday. Intel and Federal express have much in common: both are trading for about 6(x) cash-flow and both have a heavy capex requirement that creates operating leverage in good markets, but unfortunately drags on investment and returns in economies such as we have today. You need patience with FDX but the stock is far from broken. (long FDX and INTC)

* Look for our Bed Bath & Beyond and Oracle (ORCL) previews on SeekingAlpha this week.

* One last point – most of the market commentary / outlook / predictions on CNBC this week have turned BULLISH.

Thanks for stopping by the Fundamentalis blog. Hopefully, you enjoyed reading this as much as I enjoy writing this for you, and hopefully you gain some market insight / benefit from it.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

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