The earnings reports from this past week, were not encouraging, to say the least. Alcoa (NYSE:AA), YUM! Brands (NYSE:YUM) and Monsanto (NYSE:MON), all had earnings and revenue impacted by China (YUM), or commodity prices (MON), or both (AA).
Energy has been a substantial drag on S&P 500 earnings for quite a while—since Q4 ’14—with the substantial year-over-year declines for the Energy sector not expected to stop until Q3, 2016, when the sector is expected to show its first y/y growth since Q3 ’14.
Here is a brief chronology of the y/y growth of Energy sector earnings, both actual and estimated:
- Q2 ’14: +17%
- Q3 ’14: +10.3%
- Q4 ’14: -21.8%
- Q1 ’15: -57.9%
- Q2 ’15: -56.4%
- Q3 ’15: -64.6% (est)
- Q4 ’15: -63% (est)
- Q1 ’16: -23.8% (est)
- Q2 ’16 -12.3% (est)
- Q3 ’16: +25% (est)
Source: Thomson Reuters “This Week in Earnings” dated 10/9/2015
If you are a regular reader, you’d know the influence Energy is having on S&P 500 earnings, which is why it is somewhat puzzling that one continues to hear financial media make comments about an “earnings recession” and Q3 ’15 being the worst quarter of y/y growth for S&P 500 earnings since the Financial Crisis, without reference to the drag Energy is having on the index, or Energy and Basic Materials for that matter.
Together, Energy and Basic Materials comprise probably less than 10% of the S&P 500 by market cap.
Financials and Technology still comprise about 40% of the S&P 500’s market cap. While I worry about Tech’s China exposure, particularly for a brand like Apple (NASDAQ:AAPL), Nike (NYSE:NKE) proved with 30% revenue growth in China that if you have the right product and execution, the “macro” might not matter. Half of YUM’s revenues are China-centric, while Nike’s is a smaller percentage. (Long AAPL, NKE.)
In Q3 ’12, S&P 500 earnings grew less than 1%. The “sturm and drang” coming into those results and the low expectations didn’t inhibit what turned out to be a solid 4th quarter of 2012 rally.
We'll get a number of Financials reporting this week, most of the larger banks, as well as Goldman Sachs (NYSE:GS) and Schwab (NYSE:SCHW). (long JPM, WFC, BAC, GS, SCHW). I would venture a guess that the banking system today is “cleaner” from a credit and “risk” perspective than at any time in the last 20 years. I lived through the commercial real estate crisis of the late 1980s, the LTCM crisis of the late 1990s and obviously 2008, and while Financials might not represent a lot of “reward” today, they sure don’t seem to represent a lot of risk either. Absent Bank of America’s 2015 results, investors can expect both low-single-digit earnings and revenue growth from the sector in 2015.
Bottom-line: After Energy, investors should expect “mid-single-digit EPS growth” (at least) from the S&P 500 in Q3 ’15.
By the numbers:
- The forward 4-quarter estimate this past week fell to $125.88, from last week’s $126.58.
- The P/E ratio on the forward estimate as of Friday, October 9, 2015 is 16(x), which could be pricey if core S&P 500 earnings growth is 5% – 6%.
- The PEG ratio is still negative given the negative y/y growth rate of the forward estimate, thanks to Energy
- The S&P 500 Earnings yield is 6.25% as of Friday, 10/9, versus 6.49% last week. The S&P 500 earnings yield has been above 6% for 8 straight weeks.
- The y/y growth rate of the forward estimate was -2.65%, versus last week’s -5.68%.
Conclusion / summary: Clients now own a roughly 5% Energy and Emerging Market position coming into calendar Q4 ’15, after not owning either sector for years. The price of crude oil started to fall dramatically starting on September 1, 2014, so Energy starts to lap the earnings collapse that started in Q4 ’14 and Q1 ’15. Even if crude oil just stays stable, forward Energy estimates, particularly for the back half of 2016, should start to stabilize. There are 10 sectors within the S&P 500 and three of those sectors – Telco, Utilities, and Basic Materials – represent less than 10% of the market cap of the S&P 500.
Financials continue to represent a safe haven sector, in my opinion. While the Fed's CCAR (Comprehensive Capital Analysis and Review) and such represent the proverbial “genital cuff” (think “Dirty Rotten Scoundrels”) for the sector, banks have more capital today than ever relative to the risk being taken, which means more buybacks, more dividends, and less balance sheet risk.