2012 will likely go into the history books as a pretty good year, with the S&P 500 up roughly 12% year-to-date, although that could change dramatically with Monday, December 31′s trading action, given the events in Washington. (As this is being written on Saturday / Sunday morning, S&P 500 futures are down 26 to 1,384 and the Dow futures are down 226, to 12,770 thanks to the lack of anything resembling an agreement coming from Washington after Friday’s market close. After-hours futures prices can be pushed around pretty easily given the lack of liquidity, so the action that will really count will be Monday morning’s futures as we near the opening bell on 12/31.)
Per ThomsonReuters, the “forward 4-quarter” earnings estimate as of Friday, December 28, was $108.83, down from last weeks $108.91, and at the lower end of the three-month range between $107.89 and $112 from early October.
Thus, the S&P 500 is trading at a little under 13(x) forward estimates, for a projected 10.8% S&P 500 earnings growth rate in 2013.
2012 was better than a lot of folks thought, given the volatility in 2011. Here is an analysis by S&P 500 sector on the earnings growth expectations for 2012 as of Jan 1 (first column), and then the actual earnings growth rate for each sector as of 12/28/12 (second column). Finally the 3rd column is the year-to-date performance of the SPDR ETF (as of Friday, 12/28, and per Briefing.com), which tracks that particular S&P 500 sector:
Consumer discretionary: +13%, +10.2%, XLY returned 20% YTD
Consumer Staples: +8.9%, +3.1%, XLP returned 7% YTD
Energy: +2.3%, -8.8%, XLE +1% YTD
Financials: +23%, +20.2%, XLF returned +25% YTD
Health Care: +4.5%, +2.2%, XLV, +14% YTD
Industrials: +13.3%, +6.2%, XLI, +11% YTD
Basic Materials: +9.6%, -12.7%, XLB, +10% YTD
Technology: +8.9%, +3.1%, XLK +12% YTD
Telecom: +7.7%, +1%, IYZ +14%
Utilities: -2%, -6.6%, XLU -4%;
S&P 500: +10%, +3.7%, SPY +12% to 13% (when incorporating dividend)
A couple of observations on the above data:
* Every sector saw earnings growth expectations get revised lower as we progressed through 2012, as 2012′s y/y earnings growth for the S&P 500 was the lowest since 2008;
* The correlation between the SPRD ETFs and the S&P 500 earnings growth rates, can be distorted by market cap, e.g. the XLF is all of the mega-cap banks. The SPDR ETF’s annual returns do not correlate or match precisly the actual returns by sector for the S&P 500, given the stock selection and the weightings for the SPDR ETFs;
* Basic Material’s earnings got whacked pretty hard in 2012, but surprisingly the XLB ETF was up 10% on the year thanks to Monsanto, (MON), the XLB’s largest single stock at 10% of the ETF. MON looks to be up about 32% year-to-date, not bad for a sector where earnings growth has been revised considerably lower – down 22% – in the last 12 months.
* Healthcare did well, thanks in part to the resurgence of large-cap pharmaceuticals stocks. Johnson & Johnson (JNJ), Pfizer (PFE) and Merck (MRK) are 32% of the XLV and the top three holdings in the ETF; (Long JNJ, MRK, PFE)
So what are the current S&P 500 consensus earnings estimates by sector for 2013 ?
- Consumer discretionary: +14%
- Consumer staples: +9.8%
- Energy: +3.9%
- Financials: +16%
- Health Care: +6.8%
- Industrials: +8.5%
- Basic Materials: +21.8%
- Technology: +12.5%
- Telecom: +21.1%
- Utilities: +0.9%
- S&P 500 +10.8%
* Basic materials is expected to generate the highest earnings growth by sector in 2013, which would be a complete reversal of 2012′s drop. Consumer discretionary, financials, tech and telecom, are all sectors expected to grow earnings faster than the S&P 500 in 2013.Telecom is expected to show the 2nd fastest rate of growth in 2013, +21.1% as estimates stand currently.
* Energy has seen the sharpest decline in the past 3 months in terms of expectations for 2013, from 7.8% as of October 1, to 3.9% as of Friday. Financials is the only sector to be revised higher for 2013, from +12.6% on October 1 to +16% as of Friday, 12/28. (Energy might continue to struggle in terms of earnings growth in 2013, if the US continues to find more supply. )
Our three largest sector overweights in client accounts remain the same: Technology, Financials and Industrials. We managed to avoid utilities this year, (thankfully) although the no-weight and underweight hurt us last year.
Financials were the pleasant surprise in 2012, and I would speculate Industrials could be the pleasant surprise in 2013, given the recent resurgence in China, Japan and Europe.
Try and ignore Washington: there will be some kind of a deal, and I suspect tax reform will occur gradually over 2013. We still think S&P 500 earnings bottomed with q3 ’12s +0.1% year-over-year growth rate, and that year-over-year growth will gradually get stonger as 2013 unfolds.
* One of our best sales this year was Best Buy (BBY) in June, at better than $20 per share. We managed to eke out a gain in client accounts on BBY, and yet, given their cash-flow, I never thought the stock would sink this low. We recently bought some Dell (DELL) and Hewlett-Packard (HPQ) for a longer-term patient account. Both DELL and HPQ are about as cheap (actually cheaper) on a cash-flow basis as BBY was, when we bought it. We have tight stops on both stocks. The recent low of $8.69 on DELL where it traded in mid-November is one such stop. $11.35 is the other stop for HPQ. The PC sector is being left for dead, and maybe that is the right place for it, but the headlines are now overwhelmingly negative for the sector, and I just dont think the PC is going away immediately.
The valuations on DELL and HPQ are almost Armegeddon-like:
DELL is trading at 0.30(x) 4-quarter trailing sales (i.e. price to sales), 1(x) cash-flow (excluding the balance sheet cash), about 1.5(x) free-cash-flow (again when excluding balance sheet cash from market cap), 0.20(x) entrerprise value (EV) to sales, and 3(x) enterprise value to cash-flow. DELL has an 18% free-cash-flow yield.
HPQ is trading at 0.22(x) 4-quarter trailing sales, 3(x) cash-flow and 4(x) free-cash-flow and HPQ sports a 26% free-cash-flow yield.
Interesting that even with the Goldman Sachs upgrade of Dell, it is HPQ that showed margin improvement in the 3rd quarter, even though DELL’s margin continued to slide. (Long GS, DELL, HPQ).
Limit your risk with these stocks, but the valuations are too cheap in my opinion. We had to buy some recently.
* We added to Coca-Cola (KO) and Merck (MRK) just after the holiday: a great technician we follow, Gary Morrow, tweeted a chart on KO this week that was too compelling to ignore. KO is the classic defensive stock, and in this market, defense wins championships.
* Ford Motor(F): what a run this stock has had. $13 is a key technical level, a price level in the first quarter, where it was rejected numerous times. In Jan ’12, Feb ’12 and then March ’12, Ford hit and was rejected at the $13.04, $13 and $13.05 levels before getting crushed through the summer. One of our “dirt cheap, value stocks” in 2012, we remain long F. The cash-flow valuation of 5(x) automotive cash-flow is too cheap to ignore, as the balance sheet will continue to improve, and the company saw a record automotive pre-tax operating margin in Q3 ’12.
* Ford’s (F) stock lagged most of the year, but as of Friday’s close, and excluding the dividend, the stock is up 20% in 2012, all of that return coming in the last 45 days of the year. Could it be a play on the European recovery? Absolutely, but we own F because it is selling better quality cars, that Americans want to own, while the foreign OEM’s run into problems (i.e. Toyota (TM)). Success brings its own set of problems.
* Alcoa (AA) was another of our dirt-cheap value stocks coming into 2012: for the year, excluding the dividend, AA is flat on the year, closing at $8.65 on 12/30/11 and ending at $8.50 on 12/28/12. Monday will be key as to whether AA can close in the green this year. No question it will underperform the S&P 500. Trading at 75% of tangible book value, AA is a deep value play. The problem is margins for the aluminim smelter: every quarter since June ’11, AA has beaten revenue estimates by 3% – 4%. The problem is the company can’t generate earnings from the better-than-expected revenues. Aluminum inventory is an issue too – thought to be about 3(x) current demand, versus copper inventory which is much more in balance and prone to an inventory deficit, thus AA is (or was) being neglected for Freeport-McMoRan (FCX). A resurgent Chinese economy could help the price of aluminum. Still long and still wrong on AA.
* Our equity portfolios are probably 70% value stocks and 30% growth stocks, within the overall 60% / 40% – 70% / 30% asset allocation mix. Our growth names include Visa (V), Starbucks (SBUX), Amazon (AMZN), and Google (GOOG). (Long all mentioned)
* To conclude the weekly missive, here's, Norm Conley with a tweet on income tax receipts. Because of the ideological and political rift that has split the country in half, our conservative clients seem to get angry when i say that despite Washington, there seems to be an underlying strength to the economy. As a young analyst in 1992, after Bill Clinton was elected promising wealth re-distribution, socialized healthcare and higher taxes, I was amazed the market continued to trade higher in 2003. I remember thinking at that time, “Let the market tell you where it wants to go” – a maxim I forgot in 2007 and 2008 as earnings estimates were climbing.
It has been almost 13 years since the S&P 500 has made a material new high, despite the outbreak of capitalism around the globe. Eventually Europe will right itself. Forward earnings estimates today, are just a touch higher than where they were in July 2008, $108 versus $102 - $103. Something will break us out of this long, flat trading range, although I cant say we wont drop 10% before that happens.
Wall Street predictions are notoriously bad, and no one person, firm, style, strategy, or fund is consistently right about the future, unless you are Bernie Madoff.
Final point: the 10-year Treasury hasn’t made a new low in yield since late July, ’12. Interesting that with the late week Cliff worries, we still didn’t see a huge Treasury rally. The Municipal Bond ETF (MUB) is still weak and below its 200-day moving average. Something happening in muni land for sure.