Safe Haven Financials, Technology Oversold, Treasuries Will Be The Tell

 | Nov 05, 2012 12:37AM ET

“Everybody loves money. That is why they call it money.” Danny DiVito from “The Heist”. (Good – but not great - movie.)

The only comment I have about the Presidential election, is that whoever wins the White House and the Senate in terms of the parties in charge, I would hope that they can balance the need for the US economy to grow a faster rate, with real deficit reduction.

The need for deficit reduction is substantial. As Simpson-Bowles concluded, “the era of deficit denial is over”. Dr. David Kelly, JP Morgan’s Chief Economist, says that if Congress and the President try to take the deficit down from its current 7% of GDP to somewhere in the 3% range, this will slam the brakes on economic growth. That kind of deficit reducton would be too contractionary for the US economy. It would probably result in the Treasury rally continuing, but a too-drastic attempt to reduce the deficit wouldn’t be good for the US stock market.

This coming Wednesday morning, if I had to pick one data point to watch that might fully reflect or discount Tuesday’s results, it would probably be the 10-year Treasury yield.

The “forward 4-quarter” earnings estimate for the S&P 500 fell slightly last week to $110.58, down from the previous week’s $111.14, and has now fallen 5 weeks in a row, although not by a big percentage. Year-over-year growth for the key metric is 5.3%, still above the late July, early August nadir of 1% year-over-year growth.

With 367 of the S&P 500 reporting Q3 ’12 earnings month-to-date, Q3 ’12 S&P 500 earnings have fallen -0.6% year-over-year while revenue growth has fallen -0.4% year-over-year.

Q4 ’12 earnings growth has slowed to an expectation now of +6.7%, versus +9.9% as of October 1st, and +13.9% as of July 1st. The expected year-over-year growth for technology earnings estimates for Q4 ’12 is now -0.1%, versus +9.4% on October 1st, and +15.3% on July 1st, so analyst estimates have really reined in expectations for the S&P 500′s largest sector, for what is typically the seasonally-strongest period of the year for tech spending. A lot of this is Apple’s typically-low-balled guidance for the Christmas holiday, since Apple (AAPL) is now such a big part of technology and the S&P 500. (More comments on AAPL below.)

Financial sector earnings estimates are a pleasant surprise: Financials are the only sector within the S&P 500 to have seen higher growth expectations since July 1, for Q3, ’12, Q4 ’12, and Q1 ’13. Here is a brief table of how Financial sector earnings estimates have tracked the last 3 months: (near column is week of Nov 2, middle column is as of October 1, 3rd column is as of July 1):

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Q3 ’12 +7.6%, +5.3%, +4.2%

Q4 ’12 +30.2%, +28.9%, +26.6%

Q1 ’13 +9.6%, +8.4%, +6.4%

No other sector within the S&P 500 shows this steady progression in earnings, which might help explain the good relative strength in financials since this S&P 500 correction started in mid-September.

Finally, according to the attached spreadsheet, this is the 2nd consecutive quarter where analyst estimate increases weren't convincingly above the 50% level. This spreadsheet goes back quite a way, with the highlighted blocks showing the key reporting season for each quarter. As the reader can see, the 2nd quarter was actually worse than the current quarter – at least in Q3 ’12, we are getting to 50% / 50% revision rates, indicating that in the last few weeks, analysts are becoming a little more aggressive on estimates.

We think Q3 ’12 will be the bottom for S&P 500 earnings although Q4 ’12 is looking a little gamey too. I didn’t think Q4 ’12 estimates would be reduced to this level.