During one of those famous Illinois winter cold snaps about 4-5 years ago, a friend of mine, Tom, was driving from Chicago to Springfield, Illinois, in his big, honking, 4-door Lexus. He hit some black ice on I-57, about halfway between Chicago and Springfield, Illinois, and started spinning out of control. Even though he was traveling south, the front of the car was pointed west, and his final thought just before he was T-boned by one of those big food trucks (he is telling me this a few months later, laughing hysterically, and unhurt from the incident) was, “This can’t be good.”
For those of us who manage money for a living, watching the weak S&P 500 open Friday, after a remarkably strong payroll number, and the collapse during the final 30 minutes of trading in the Dow 30, the S&P 500 and the NASDAQ, I couldn’t help but recalling Tom’s last thought before being torpedoed by the large truck and think, “This can’t be good.”
All Eyes on Q4 ’15 Earnings
Alcoa (N:AA) reports Tuesday night, January 12th after the close. This past week, AA mothballed more smelting capacity, which can't be good for the pending spin-off. The downstream business is the only part of the business investors want today, but the upstream smelting business is still weighing on the overall business. (Long small position in one account.)
CSX Corporation (O:CSX): Wednesday, January 13th – the first look at railroads and Transports for Q4 ’15. Railroads dropped with the price of crude since so much crude was being transported by rail. (Never owned rails, just FedEx Corporation (N:FDX), with a smaller position in FDX currently.)
JPMorgan Chase & Co (N:JPM) and Intel (O:INTC): JPM, the first major bank on the list, is set to report at Thursday's open, before the bell, and then Intel (O:INTC) reports after the close on Thursday night. Clients are long both.
Wells Fargo (N:WFC) and Citigroup (N:C) report Friday morning before the opening bell. As you will see shortly, Citi is distorting the Financial sector growth rate. Ex-Citi, Financials are expected to grow low-single-digits. Never owned Citi. After the Traveler’s acquisition in the mid-1990s, I sold the position and bought other banks. Clients are long Wells Fargo.
Here is a spreadsheet requested of Thomson Reuters showing “core” S&P 500 earnings “ex” a number of special factors: FC-Q4’15TRearningspreview (Thank you David Aurelio and Greg Harrison).
Some key points from the detail: The two largest sector weights in terms of market cap within the S&P 500 are Technology and Financials, with respective weights of 19%-20% and 15%-17%. Ex-Citi, the Financials are expected to grow just 2% in Q4 ’15 in terms of y/y sector earnings growth, which is in line with the overall Financials' expected revenue growth. Technology in Q4 ’15 is expected to decline 4% y/y as of today, but ex-Apple’s (O:AAPL) 4% S&P 500 market cap weight, and 15% weight in the QQQs. Technology will decline 7.7% – that truly surprises me given Microsoft (O:MSFT), etc. (Long Apple, Microsoft, Intel, etc. and overweight Technology.)
I continue to think Financials are a safe haven. With such low expectations for earnings growth, the sector will decline with market corrections, but for those expecting a “2008-type” scenario within the sector—or even the S&P 500 in general—to say that seems remote, is polite. Financials were decimated in late 2008/2009 thanks to the dilution caused by the Fed and Treasury forcing the banks to raise capital. The majority of banks today are taking far less balance sheet risk and holding far more capital against that risk.
Technology and Financials went through their truly horrific bear markets in 2001-2002, and then 2008-2009. Energy is seeing its day of reckoning, along with Basic Materials.
John Butters at Factset noted this weekend that for Q4 ’15, the reductions to Q4 ’15 S&P 500 earnings estimates “are within average levels”.
Analysis / conclusion for Q4 ’15 earnings: In Q1 ’15, ex-Energy and Apple, S&P 500 earnings grew close to 9%, so if the S&P 500 does grow 5% in Q4 ’15 ex-Apple and Energy, it will represent a slowing of core earnings. Paul Hickey at Bespoke has long written that for just about every quarter since 2009, sentiment around S&P 500 earnings has been pretty horrid coming into the releases, only to find that S&P 500 earnings growth was ultimately not that bad. There was no such comment in Bespoke’s weekly newsletter this weekend, (and if there was I missed it in the weekend reading) but one of the better contrarian elements to this market off the March ’09 low, has been the persistently poor outlook for S&P 500 earnings growth, only for that sentiment to be wrong.
A 1-year perspective on S&P 500 earnings:
Factset published another interesting piece this week looking at the accuracy of one-year estimates for both top-down and bottom-up perspectives.
Jeff Miller, the great blogger over at Dash of Insight and I have talked about this at length over the years. The trend in quarterly earnings estimates tends to hit a nadir just prior to the start of that quarter and then works higher during the actual earnings releases.
Looking at the full-year estimates, my experience has been the same. It is clear that Energy and Commodities have distorted the overall S&P 500 earnings growth in 2015 and possibly 2016. Current Thomson EPS consensus is looking for 8% growth in 2016. Factset (per John Butter’s piece and per their weekend release) linked above, is looking for 7.5%.
Analysis / conclusion for 2016 earnings: No question, the calendar 2016 guidance will matter on the calls this coming week, and it could be extrapolated for the rest of the sector until analysts get more data points. Could the S&P 500 see two consecutive years of flat earnings growth? I think it depends on the Energy sector. Big reductions to capex have been expected for a while and we saw them in the October-December analyst meetings for large-cap Energy companies, but those capex cuts do help to preserve cash-flow. It is difficult to envision an Energy sector that sees a 59% y/y decline in earnings as is expected for 2015. Currently the 2016 decline is projected at 12%.
I have yet to see an Estimize or Zacks projection for 2016.
S&P 500 data by the numbers (Thomson Reuters data):
- The forward 4-quarter estimate for the S&P 500 saw its quarterly bump this past week, to $125.64 versus last week’s $122.41. This is normal, and expected.
- The P/E ratio on the forward estimate is 15(x) as of Friday, January 8, 2016.
- The PEG ratio is still negative, which will be discussed in a minute, but if we use expected “core” S&P 500 earnings, the PEG ratio is still elevated at 3(x) core S&P 500 earnings. That is an elevated PEG for sure and many pundits will use the core PEG to say the S&P 500 is currently overvalued.
- The S&P 500 “earnings yield” after this past week’s 6% drop in the S&P 500 is 6.59%, the highest earnings yield (per my spreadsheet) since October 17, 2014.
- The y/y earnings growth of the forward 4-quarter estimate was a -3.46% which I didn’t like to see, after turning positive two weeks ago. When I look back at January ’15 forward 4-quarter estimates they started to fall off a cliff in the month of January ’15 so I would REALLY like to see that forward estimate turn positive in the next two weeks.
On Sunday, January 10, 2016, I’ll have some S&P 500 sector thoughts and some thoughts on 2015 and some perspectives on the current market correction.
Remember, the S&P 500 hasn’t seen a 20% correction since 2011. In my opinion that was based on an ECRI recession call that was debunked by Jeff Miller and his blog as we were in the middle of it in 2011.