Per Thomson Reuters, the forward 4-quarter estimate for the S&P 500 fell $0.02 this week to $126.75 from last week’s $126.77
The actual S&P 500 index fell 90 bps or a little less than 1% on the week.
The P/E ratio on the forward estimate is now 15.5(x) and the PEG ratio is 1.82(x).
Expected full year earnings growth is still expected at 7% using the top-down consensus EPS estimate.
Given the decline in the S&P 500 this week, the earnings yield on the S&P 500 rose 6.44% from last week’s 6.38%, although still well under the record July ’12 high of 8.25%.
The year-over-year growth rate on the S&P 500 slipped to 8.51% from last week’s 8.66%. The y/y growth rate of the forward estimate is still at the higher end of its recent range, and the highest y/y growth rate since 2012.
The forward growth rate is a key metric and you will read why in a minute.
This past week we heard from Alcoa (NYSE:AA) and the stock rose 6.61% on the week. The Wells Fargo (NYSE:WFC) earnings report isn’t included in this week’s data. (Long AA, WFC)
This coming week we hear from a plethora of financials on Q2 ’14 results.
Analysis / commentary: This week I read another article on Twitter debunking forward earnings estimates, mainly the forward P/E ratio. With fellow alums from TheStreet.com, Jeff Miller of a Dash of Insight and a decent-sized money manager and Rob Martorama, of RightBlend Investing, an advisor group was formed with bimonthly conference calls and this week we tackled earnings estimates and earnings data as generally disseminated in the financial press.
We wrote an article sometime in 2013 here on www.fundamentalis.com, saying how following the absolute level of earnings is meaningful, but it was a false tell in 2008. In effect, doing our weekly earnings work and watching the dollar level of the forward estimate led us to wrong conclusions about the health of the stock market (not to mention some serious denial on my part about what other indicators were flashing.)
In October, 2007, the forward estimate for the S&P 500 was roughly $100 and by July, 2008 it had fallen $2 to $98, by the third week of July. However, after analyzing the data for 2007 and 2008, here is what I found in terms of the y/y growth rate change:
- 10/31/08 -18%
- 8/29/08 -2.63% ( just two weeks before Lehman collapse)
- 6/27/08 +0.23%
- 5/30/08 +2.54%
- 3/28/08 +2.75%
- 2/29/08 +4.83%
- 2/1/08 +5.76%
- 12/28/07 +3.39
- 11/2/2007 +9.98%
Every bear market is different. The fact that – looking at it in hindsight – the forward earnings growth rate was flashing yellow back in late 2007, early 2008, looks conclusive now, but wasn’t so much back then.
What S&P 500 earnings analysis is not:
a.) A timing tool;
b.) A reliable leading economic indicator;
Treat S&P 500 earnings analysis as a doctor treats a patient’s vitals, like body temperature, pulse, blood pressure, etc. It is an important part of the overall risk assessment, but isn’t to be relied upon exclusively.
Earnings analysis is an important metric to equity and market valuation, but the fact that anyone might think the data is predictive of the market might be an erroneous conclusion. The fact that someone has a 103 degree temperature doesn’t mean the are going to die, just the same as it doesn’t precisely mean that someone with a body temperature of 98.6 is going to live another day.
The forward growth rate is an important tell, as the 2008 analysis indicates, however in 2012 the forward growth rate slowed from 10% in January, ’12 to 0% by August, September of 2012 didn’t stop the S&P 500 from trading higher right through the slowdown.
We have found the most valuable part of the analysis to be watching relative and absolute changes in sector earnings growth. Note on the blog our call on the Financial sector for 2013, in the fall of 2012. The fact that the S&P 500 revisions were working lower, and yet forward Financial estimates remained stable, was a green light for me to overweight Financials in client accounts coming into last year.
Same with Basic Materials in 2014: while the revisions have been downward for Q2 ’14 for the sector, absolute expected growth of +8.4% is the third strongest sector in the S&P 500 for Q2 ’14 and the sector is lapping very easy comps versus Q2 ’13. Note how strong Alcoa’s earnings were versus estimates this week.
By my count, using ThomsonReuters data, 22 Financials report this week, including most of the major banks. Financials, as a sector, are expected to report -3.5% y/y earnings growth. 2015 Financial sector estimates look pretty stable, but we will have a better feel as we move through the 3rd quarter.