Earnings Continue Positive, Should Improve Through 2013

According to ThomsonReuters, the “forward 4-quarter” earnings estimate” for the S&P 500 this past week slipped to $112.47 from last week’s $113.16, but is still growing at a 5.86% year-over-year rate. The year-over-year growth of the S&P 500′s foward estimate bottomed in early August ’12 at 1%, and continues to work higher. Investors should NOT ignore the growth rate of the forward estimate.

The earnings yield on the S&P 500 is still a healthy 7.3%.

Q4 ’12 earnings growth is now +3.8% (versus an expectation of +2.9% as of Jan 1, 2013) while y/y revenue growth is +2.4% with about half the S&P 500 reported for Q4 ’12.

The S&P 500 closed Friday at 1,513.17, and is closing in on the all-time high print of 1,550 from March of 2000 and 1,570 of October, 2007.

The P/E ratio on the S&P 500 today is lower than March of 2000′s 27(x) and October ’07′s 15(x), but so is the annual growth rate of earnings. As a caveat, readers – when listening or reading anything earnings-related in the financial media – should ascertain whether the source is using trailing or forward earnings. We ALWAYS use forward earnings estimates in our work blog work, since the stock market and stock prices are a discounting mechanism. In our fundamental, individual company work, we use both 4-quarter trailing and ”forward 4-quarter” estimates for our valuation work.)

If we used trailing P/E ratio’s, today’s S&P 500 is roughly 15(x) earnings, versus 17(x) in late 2007, and well over 30(x) in March, 2000, given the weights of the large-cap growth stocks.

Doing this type of analysis can result in some serious naval-gazing and “paralysis from over-analysis” so this week we are going to quote directly from the ThomsonReuters, “This Week in Earnings” report and what they are saying about Q4 ’12 earnings:

* The earnings and revenue “beat” rates are better for Q4 ’12 than in previous quarters;

* Earnings growth and “all of these positive surprises have added up to earnings growth that is stronger than anticipated prior to this earnings season”.

* The actual earnings growth rate for companies that have reported is +7.2% and given that just half of the S&P 500 companies have reported, with a current 3.8% estimate, means that the remaining 50% of companies expected to report over the next two weeks will generate flat earnings growth, which ThomsonReuters concludes seems highly unlikely;

* Our own forecast was that eventual Q4 ’12 earnings would show +5% to +6% y/y growth, so ThomsonReuters comments this week show that our forecast was accurate, and maybe even too conservative;

We’ll finish up with saying that Wall Street prognosticators have a tendency to extrapolate current trends, and if you look at the 2012 S&P 500 earnings data by quarter, you can see the gradual slowing as we moved through 2012. My own forecast for 2013 is that, just the opposite of 2012, expect the first few quarters of 2013 to start out fairly conservative at mid-single-digits, and then the 3rd and 4th quarters of 2013 will be stronger.

2013 should be the complete opposite or mirror image of 2012 in terms of year-over-year growth rates for quarterly earnings.

Stat of the week:

Consistent with our final sentences here is how the earnings growth has trended since late 2011 and how it compares to estimates for 2013:

Q4 ’13 +15.4% ( est)

Q3 ’13 +10% (est)
Q2 ’13 +6.6% (est)

Q1 ’13 +2.2% (est)

Q4 ’12 +3.8% (est)

Q3 ’12 +0.1% (actual)

Q2 ’12 +8.4% (actual)

Q1 ’12 +8.1% (actual)

Q4 ’11 +9.2% (actual)

Q3 ’11 +18% (actual)

We continue to think that – absent an exogenous shock - the back half of 2013 will see 10% y/y earnings growth for the key benchmark. Part of this will be due to easy compares from late 2012, and part will be the gradual improvement from the US economy as we move through the year, absorbing the social security tax increase, and health-care cost increases, and assuming that residential home prices continue to improve.

Asset Class/Sector/Security updates:
* The S&P 500 remains overbought, and we remain long our initial position in the Inverse S&P 500 ETF (SH) from 3 – 4 weeks ago, but S&P 500 earnings are coming in nicely ahead of estimates. The pattern since 2010 is to rally through the first quarter, and then sell off in April, etc. Each year, 2010, 2011 and 2012, we saw a pullback in the market for different reasons. In 2010 and 2011 the pullbacks were horrid with Greece and the future of the EU being the prime determinant, but last year it was Apple (AAPL) that drove the first quarter, 2012′s +14% gain in the S&P 500, and then peaked and corrected in the summer quarters. Worries about earnings really seemed to captivate the financial press in June and July, 2012. (Long AAPL)

* Apple and Intel (INTC) were our worst Q4 ’12 earnings reports in terms of our holdings. Sandisk (SNDK), Johnson & Johnson (JNJ) and Procter & Gamble (PG) were all pleasant upside suprises. (Long all names.)

* Pfizer (PFE) and large-cap pharma had a good week except Merck (MRK). Merck was down on Friday morning’s earnings release. We are ready to buy more at $41.50. There is multiple levels of technical support for Merck at $35 – $36, but I sure hope it doesn't trade that low. Zoetis (ZTS), Pfizer’s animal health unit had a very well received IPO on Friday, up 9% on 67 million shares. This is a very contrarian call, but we would actually be selling PFE here and looking to add to Merck (MRK). We are alone on this one, but it remains my call.

* The 10-year Treasury yield took out 2% on Friday, closing the week at 2.02%. The Spring, 2012 high was 2.40%. What was different about the correction in the S&P 500 following the November ’12 Presidential election, is that Treasuries never really rallied much despite the 8.5% correction in the S&P 500 – a change in character and a permanent top in Treasury prices? Could be. How Treasuries respond to the next S&P 500 correction is critical. Treasuries didn’t sell-off much in the face of Friday’s jobs report either.

* We sold our high yield ETF’s this week – iShares iBoxx Dollar High Yield Corporate Bond ETF (HYG) and SPDR Barclays High Yield Bond ETF (JNK) – and moved the proceeds into the PIMCO High Yield Fund (PHYDX), and the JP Morgan Strategic Income Fund (JSOAX). That may seems strange, but what I’m doing is essentially telling clients that with high yield credit spreads close to all-time tights to Treasuries, but with credit in general still cheaper to Treasuries than in past cycles, I’m going to let far more intelligent asset-specific managers make the individual bets, and I’ll make the top-down buy-and-sell decision. We are still credit overweight, but PIMCO is more conservative at this point in the cycle, and the JP Morgan Strategic Team is more “unconstrained”. Frankly I think PIMCO and Gross are too conservative on the US economy and growth will turn out better than expected, but PIMCO High Yield should still do fine in that environment.

* The interesting aspect to the US equity market is that no specific asset-class (i.e. small, mid-cap, or large) is really outdistancing itself from the pack. Just owning benchmarks will still get decent performance.

* Good chart from Gary S. Morrow on Coach (COH). A number of retailers report in February. It will be interesting to hear how the social security tax hike impacted retail, particularly low-end retail, if at all. I would think the dollar stores and names like Wal-Mart (WMT) would be the most impacted given their demographic. We bought some WMT last week. Along with some COH and Bed Bath And Beyond (BBBY). More to come on retail…

* We are staying with our tech overweight despite its undepreformance. Here is a chart from Norm Conley of JA Glynn in St. Louis. Our two largest holdings remain AAPL and IBM (long both). There is still the $425 gap in AAPL sitting there unfilled. We’d add more to AAPL at that price.

* We are going to start blogging here daily, with a chart of the day and some fundamental commentary attached to the chart. We hope readers will enjoy and make use of the content. Hopefully we’ll get Gary Morrow, the excellent technician from TheStreet to attach some of his charts and then I’ll comment about the earnings and revenue estimates. This will be a work in progress over the next few weeks and months so please be patient with us.