Finally, A Market Correction, But Earnings Aren’t The Issue
Brian Gilmartin | Oct 29, 2012 01:23AM ET
The S&P 500 has corrected 4.5% since the key benchmark ticked 1,474 in mid-September, with most of the cacophony from the mainstream media revolving around a poor 3rd quarter and 2012 earnings reports. The problem is, it has been expected for almost the last three months that 3rd quarter S&P 500 earnings would see slightly negative in terms of year-over-over earnings growth, and even flat to slightly negative revenue growth.
As of Friday, October 26th, the “forward 4-quarter” estimate for the S&P 500 was $111.14, down from last week’s $111.83, but still near the record high forward estimate recorded on October 5th, 2012 of $112.06. Year-over-year revenue growth for the 3rd quarter, 2012 S&P 500 aggregate revenues is -0.6%, versus the October 5th estimate of -0.1%.
More importantly, the year-over-year growth number for forward earnings that we cited two weeks ago was 5.54%, down slightly from last week’s y/y growth of 5.72%.
Unfortunately, S&P 500 earnings data (courtesy of ThomsonReuters) is like Presidential polls or statistics in general: you can interpret or “spin” the numbers anyway you want, and make them fit your version of reality, versus simply letting the numbers tell the story.
(One shortcoming in the ThomsonReuters data that we see, is that while the data shows forward 4 quarters earnings growth by sector, ThomsonReuters does not do the same with forward revenue estimates. The only revenue number we get by sector for the S&P 500 is the current quarter.)
Here is the ThomsonReuters earnings forecast for the S&P 500 from Q4 ’12 through Q3 ’13, and then full year 2013, both as of Friday, October 26th, and as of October 1st, 2012. What we are trying to show is – since Q3 ’12 earnings season has started – how analysts have changed their forward estimate expectations – given the current environment:
Q3 ’12: -1.2% vs -2.1%
Q4 ’12: +8.2% vs. 9.9%
Q1 ’13: +6.1% vs +7.1%
Q2 ’13: +9.8% vs +10.4%
Q3 ’13: +13.8% vs 15.9%
2013: +11.3 vs +11.6%
While consensus analyst expectations have trimmed forward quarters slightly, it is our own opinion (and we are out here alone on this one), that the S&P 500 year-over-year earnings growth will reach its nadir in Q3 ’12, and then slowly accelerate into Q4 ’12 and beyond, which is what the earnings forecasts tell us currently.
Part of our belief in Q3 ’12 being the bottom is that we have the Presidential election in 9 days, and the looming uncertainty over what the fiscal cliff means for spending and personal and corporate tax rates. There continues to be a tremendous amount of uncertainty over what the future will look like both from a political and economic perspective (and these are often one in the same), thus no one wants to be aggressive and / or bullish about expected stock prices, which in my opinion has created an unusual amount of pessimism around earnings and economic activity.
Get The News You Want
One final stat for readers: here are the year-over-year S&P 500 earnings and revenue growth by SECTOR for the S&P 500 for Q3 ’12:
Cons discr: +8% and +3.4%
Cons stpls: +1.6% and +1.7%
Energy: -16 and -17.7%
Fincls: +6.3% and -0.1%
Hlth Care: +0.3% and +5.8%
Indus: +5.4% and +1.5%
Basic Mat: -26.4% and -4.9%
Tech: +1.3% and +3.5%
Telco: -2.7% and +2.7%
Utility:-8.9% and +8.0%
The only sector that has consistently shown upward revisions to sector earnings estimates since July 1 is Financials, not just for the 3rd quarter, but the 4th quarter, 2012 estimates as well. The financial sector continues to reflect tepid revenue growth of flat to +1% (which has been the case since the March ’09 market low) even though Financial sector earnings estimates continue to be revised higher. Financials are doing more with less.
Trading / market update: The S&P 500 is finally getting to an oversold level for the first time since late May, early June, 2012. Per Bespoke, of the 10 S&P 500 sectors, technology is the most oversold of all the sectors currently. Consumer staples is next.
* Our sector overweights continue to be Technology/ Financial Services / Industrials, which has hurt our performance this year. Our performance relative to the S&P 500 has improved throughout 2012, as we have lifted our large-cap pharma exposure, but we haven’t embraced the telco and utility (part of the so-called dividend trade) sectors as we should, and as others have suggested simply because I dont feel there is the value in these sectors that I see in our top 3 sectors.
* We have had very good relative performance in our straight bond/fixed-income accounts, given our credit overweight, and our over-weighting of high yield, but I have cautioned clients that proposed tax changes around the fiscal cliff could be more disruptive than what most clients think. We have a heightened awareness around corporate high yield as an asset class, given that it is being viewed as almost a safe-haven trade today (somewhat pradoxically) as investors reach for yield. No question we are nervous about the amount of money the asset class has attracted (and attention), not to mention favorable commentary high-yield has gotten in the financial media.
* As we tweeted about this week (@trinityassetman), even though we have seen a 4.5% correction in the S&P 500 since mid-September, Treasuries haven’t rallied much despite the weak stock market. This is another indication that the “character” of the market is changing. In 2010 and 2011, we saw a quite a bit of volatility, and numerous “1% days”, but in 2012, particularly this rally since early June, July, the market has been relatively constrained and quiet, as it has slowly crept higher. Even though the S&P 5oo is off 4.5% from its high, the month-to-date return on the Treasury ETF’s are all negative (using Bespoke return data).
* Technology earnings reports have been ugly: IBM (IBM), our largest tech position outdside of Apple (AAPL), is down 10% since reporting, but even Sandisk (SNDK), which beat on both EPS and revenues, and guided higher, is down 5% since it reported. Technology will soon get to a point where sentiment and fundamentals lead to a bounce. Look at the weekly chart of Intel (INTC) (below) – the stock held and bounced off its 200-week moving average, and ended Friday close to its weekly high, despite ongoing issues with the S&P 500. Since ’04, it has paid to put INTC in the low $20′s and sell into the high $20′s. Intel is now heavily oversold on both the daily and weekly charts.
* To his credit, Vitaliy Katsenelson, the author of a couple of pretty good investment books, and a friend / colleague from our www.thestreet.com days, warned me that Windows 8 (MSFT) would not be what people thought, and the reviews have been decidedly mixed to negative. The “tile” or touch GUI, seems vastly different than the old ‘Icon and mouse” function, and although Windows 8 lets a user revert back to the traditional GUI format, the fact is – from an adoption standpoint – this new touch screen will require a longer learning curve, and take more getting used to than the previois Windows operating systems upgrades. This will slow the adoption on Windows 8, which is slow already given the increasing acceptance of tablets, and the declining relevance of the PC. Still, we listened to Rick Sherlund, the famed software analyst that was formerly with Goldman Sachs during PC and tech halcyon days of the late 1990′s and he gives Windows 8 a “thumbs up” review, although he suspects it will take some getting used to on the part of consumers and the enterprise.
* Given the above, the PC sector is experiencing a “nuclear winter” in our opinion. We like Intel here under $22, and Microsoft (MSFT) even more at $26. Haven’t bought Dell (DELL) or Hewlett (HPQ) yet, as we want both to base more. We think the next PC upgrade cycle could be as much about job growth as technology. The PC will not be relegated to the graveyard completely. (Long INTC and MSFT – may add more this week, depending on the action).
* Google (GOOG) is a maddening stock, as Barron’s noted and we completely agree. The way it trades seems to be completely detached from any economic reality. We maintain a small position in the stock within client accounts, but it is – without a doubt – the most puzzling trading action we’ve ever seen. GOOG traded from $570 to $770 between 2nd and 3rd quarter, 2012 earnings, on very little substance. After this most recent earnings fiasco, the stock will now likely chop around from the low $600′s to the $700′s aimlessly.
* Amazon (AMZN) is the best secular growth story in retail, but seems ridiculously overvalued on any meaningful valuation metric. That being said, AMZN with $63 billion in expected annual revenues in 2012, represents just 1% of total global retail sales. Amazon’s annual rev’s are just 10% – 12% of Wal-Mart (WMT), still, to give the reader some perspective on Amazon’s growth potential. (long AMZN and WMT. ) We still love WMT even though it is still consolidating its breakout over the all-time high of $70.25. (long AMZN, WMT and would look to add to both on weakness.)
* Housing data continues to improve, but homebuilder stocks have stalled, which we like to see. It was October, 2011 when the homebuilders really started to move higher and names like Toll Brothers (TOL) and Lennar Corp. (LEN) have doubled in the last year. We prefer Home Depot (HD) at this point, if you have to buy something housing related, but even then, I think Wal-Mart is partially a housing-related stock. The homebuilders will start to lap higher results when we enter into 2013, and the market might be starting to reflect that. Masco (MAS) reports this week. It is my own opinion, but the homebuilder’s earnings seems to be inflated thanks to lower-than-usual effective tax rates even though these quarterly reports are strong. I can’t find any good 3rd party research on what “normalized earnings” should be for the homebuilders, or if this is even the right way to look at the sector. (Long HD, TOL, LEN, WMT)
To conclude our ramblings for the week, we have seen our first decent market correction, now 6 weeks longs, since early June, (which lasted about 8 weeks), with technology as oversold as I have seen it since late 2011. Corporate earnings estimates, either current or forward, havent changed that much, so take the financial media cacophony with a grain of salt.
I do think the Presidential election and the uncertainty over 2013 tax rates and spending, has created an unusual amount of angst on the part of both the longer-term investor and the corporate manager, all of which will seem clearer when we wake up on Wednesday, November 7th.
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