Earnings / Market update: December 1, 2012 – As Cliff Looms, S&P 500 Earnings Remain Stable

According to ThomsonReuters’s This Week in Earnings, the “forward 4-quarter” estimate  for the S&P 500 as of Friday, November 30, 2012 was $109.42, down from the previous week’s $109.44 and still towards the higher end of the 4th quarter range of the $107 low and the $112 high.

Since late July 2011, the “forward 4-quarter estimate” has ranged from $107 to $112 so basically the forward S&P 500 estimate has been locked in a range for 18 months, as Europe, Washington, and the US economy continue to swirl. We had a brief dip into the $105 area in late March, 2012, but as soon as we roll into each new quarter, that forward estimate pops higher.

The point being that as we exist in an investing world of constant drama and much “sturm and drang”, S&P 500 earnings estimates resemble “Old Man River”, i.e. they keep rolling along, with steady albeit subdued, growth.

Does following forward estimates have merit ? We think so, and one of our favorite bloggers does too, i.e. Jeff Miller, from “A Dash of Insight”. Here is the link we were looking for last week, :  http://oldprof.typepad.com/a_dash_of_insight/2010/10/profiting-from-forward-earnings-estimates.html, from Jeff’s blog.

The following is a recap of 2012 earnings growth by sector (first column) as of Friday, November 30th (2nd column), and then again as of Jan 1, 2012 (3rd column). Finally we give the approximate year-to-date sector return for each sector to see if there is a correlation between sector earnings growth and performance:

Consumer discretionary: +10.7%, +13% and +23% YTD

Consumer staples: +3.2%, +8.9% and +13.3% YTD

Energy: -8.5%, +2.3%, and +4% YTD

Financials: +21.9%, +23%, and  +23% YTD

Healthcare: +2.3%, +4.5%, and +17.5% YTD

Industrials: +6.4%, +13.3%, and +12.4% YTD

Materials: -12.4%, +9.6%, and +11.4% YTD

Technology: +3.3%, +8.9%, and +14.5% YTD

Telco: +1.5%, +7.7%, and +20% YTD

Utilities: -7.5%, -2%, and +1% YTD

S&P 500: +4.1%, +10%, and +14.8% YTD

As the reader can quickly tell, looking at the last line, the S&P 500 is expected to grow earnings 5% this calendar year in 2012, even though the S&P 500 is up about 15% year-to-date. This is the opposite of what happened last year when the S&P 500 grew earnings 15% year-over-year, and yet the S&P 500 was up just 2% – 3% in 2011.

It would be easy to get lost in this data and start comtemplating your navel, but what the earnings data doesn’t help distinguish, is the influence of market cap on S&P 500 performance. You have to remember, the S&P 500 is a “market-cap weighted” index, so the companies with the higher market cap can have a disproportionate influence on performance.

Look at the Tech sector: earnings estimates have fallen all year, but Apple (APPL) is the #1 company in terms of market cap in the S&P 500 (let alone the tech sector). Apple is up 44% year-to-date in terms of its return, (excluding the dividend) and has helped keep the technology sector relevant in terms of year-to-date returns, vis-a-vis- the S&P 500.

Consumer discretionary too: no doubt helped by housing and the homebuilders sector, consumer discretionary is one of the top performing sectors +23% YTD. Here is a graphic on consumer discretionary’s outperformance vis-a-vis the Russell 1000 as detailed by Norm Conley of JA Glynn Advisers out of St. Louis. http://twileshare.com/zfh. See more on Toll Brothers (TOL) found below. They report Tuesday, December 4th before the bell.

So what is the point of all this ? The worst sectors this year in terms of absolute earnings growth, were (are), Energy, Materials, and Utilities. Which sectors are the worst three sectors of the S&P 500 as measured by YTD performance ? Materials (+11.5%), Energy (+4%) and Utilities (+1%).

By the way, this is very much unlike last year, when Utilities really outperformed and yet the earnings growth wasnt there. We’ll have more on this towards year-end.

The important element from a portfolio management perspective, is that when looking at sector earnings growth, and performance, don’t ignore market cap.

Ironically, despite the Cliff and the constant cacophony of negativity from the financial media, this year has been more of a “normal” year for the S&P 500 and sector returns, relative to earnings growth, than 2011.

Stay focused on your strategy and ignore the tripe in the press. Earnings matter – they always have, and they always will.

Sector/Stock/Market update:

*Tiffanys (TIF) reported earnings last week, and we had the right call (we think) in our earnings preview on SeekingAlpha. Here is our preview http://seekingalpha.com/article/1029361-tiffany-s-earnings-preview-premium-brand-but-we-worry-about-cash-flow, and here is Gary Morrow’s technical analysis on TIF, found on Twitter. Gary is a friend and still a contributor to www.thestreet.com , who specializes in technical analysis. Check the chart on TIF here: http://twileshare.com/zfi. I’d love to own it under $50.

* Bespoke had a couple of good notes out this week on “December seasonality”: in the last 20 years, stock returns have been positive 70% of the time and in the last 50 years, December returns have been positive 68% of the time, and over the past 100 years December returns have been positive 73% of the time.  (Nice record – hard not to be long, despite worries about the Cliff.)

* Bespoke had another interesting graph on Domestic vs. International Co’s within the Russell 1000: Domestic’s (100% of revenues generated within the US) have outperformed Internationals (more than 50% of revenues outside US) have outperformed by 16.6% to 6.6% (or 1,000 basis points, since last December, ’11. This will reverse at some point – in our opinion this has a lot to do with the dollar’s relative weakness. We are probably overweight more large-cap international than Domestic.

* Here are the sector returns (per the SPDR’s) for the S&P 500 for November:

SP 500 +0.28%

* Technology +0.90% (Apple was down 1.6% in November)

* Financials -0.88% (Financials have done well YTD. still like the sector. JP Morgan one of our largest positions – just 8(x) core earnings. Still expecting $5 eps in 2012, despite London Whale mess.

* Consumer Staples: +1.84%

* Consumer Discretionary +3.17% (Housing and Housing-related doing well)

* Industrials: +1.75%

* HealthCare: +0.52% (love pharma and AMGN)

* Utilities – 4.28% (just hammered in November)

* Energy -1.22%

* Telco: VZ -1.16%, T down -1.33%

* Materials: +1.86%

(All returns exclude dividends)

* We remain overweight technology, financials and industrials in client accounts. Our top two holdings in client accounts remain AAPL and IBM.

We mis-spelled his name, but two weeks we wrote about El-Erian (PIMCO Co-CIO) saying “More Fed” is on the way. Not a surprise given the Cliff.

Most Treasury and credit ETF’s had positive total returns in November. Municipals outperformed Treasuries and taxable high yield. Flood to muni’s by the wealthy given higher tax rates coming – that might not be the best move. However given President Obama’s plan as delivered by Geithner last week, it does look like more taxes are in order vis-a-vis spending cuts. It would be remarkable if taxes were raised THAT much, and the muni market lost its tax advantage. Talk about screwing the investor class.

* Two final points of note: Toll Brothers reports Tuesday morning and consensus estimates are looking for $0.24 on $567 ml in revenue. Check our earnings preview over on www.SeekingAlpha.com for more detail and a thorough earnings preview. (Long TOL)

* Little noticed this week was Amazon’s $2.5 billion debt issue, which was rated Baa1 / AA-. That is a weird ratings spread – basically high investment grade and low investment grade. You dont normally see that kind of a ratings credit spread on a company. I think it speaks to both the rating agencies in the post 2008 world, and the emergence of “displacing” or disruptive technology companies like Amazon (Long AMZN.) Very weird – we will be writing more on this in a different venue.

Thanks for stopping by and thanks for reading.

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager



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