It was a difficult week for the markets, which for the most part focused on earnings. So far, 54% of the S&P 500 companies have reported third-quarter results that have been uninspiring and shown lackluster growth because of the macro uncertainties and currency headwinds. In the S&P 500, 63.4% companies have beaten expectations, 24.2% have missed, and 12.5% have been in line. Technically, earnings are up 2.45% year over year, compared with the 1.8% year-over-year expectation, and revenue is up 0.22% year over year, compared with the 0.6% year-over-year expectation.
Health care, financials and industrials have been the three groups with the largest positive earnings surprises, while utilities, telecom and materials have had the most negative surprises. Expectations were low headed into earnings, but the lack of top-line growth is the reality, and it has been exacerbated by the unknown outcome of the presidential election and fiscal cliff. We've been encouraged by the strong margins as management teams continue to scrutinize costs and seek productivity gains in order to counter the broader issues. And cash flow has also been another bright spot: U.S. corporate balance sheets now have more than $2 trillion (just under $1 trillion for S&P 500 companies). Lower commodity prices and a weaker dollar will also help going forward.
As for economic data, Friday's first read of third-quarter GDP came in slightly ahead of plan at 2%. Plus the drought in the Midwest took away 0.5% from the GDP report, so underlying growth continues to muddle along. Details of the GDP report show that housing and the consumer continue to improve and more than offset lackluster business investment, but markets remain unsettled because of the uncertainties about the fiscal cliff and upcoming presidential election. It will be a challenge for markets to move up materially in front of the elections, unfortunately. But we do expect money to return from the sidelines once there is resolution to the election, which should give us some answers on what will be done on the fiscal cliff.
The S&P 500 is off 4.4% from its highs and trades at an uncommanding 14x forward estimates (using a conservative $100 estimate this year). As a result, we've been putting money to work on beaten-down names, but we are still quick to take our gains as well. We sold out of our Weyerhaeuser (WY:NYSE) and Home Depot (HD:NYSE) positions and used the gains to add a new position in Caterpillar (CAT:NYSE) and increase our bets in Bed Bath & Beyond (BBBY:Nasdaq), Bristol-Myers Squibb (BMY:NYSE) Dollar General (DG:NYSE), KeyCorp (KEY:NYSE), Mondelez International (MDLZ:Nasdaq), News Corp. (NWSA:Nasdaq), and Southwestern Energy (SWN:NYSE). We downgraded Boeing (BA:NYSE) to a Two because it is trading range-bound until there is resolution on the fiscal cliff, and we upgraded Apple (AAPL:Nasdaq) to a One on the 13% pullback in shares.
Next week another 21% of the S&P 500 companies report earnings, bringing the total by the end of the week to 75%. We expect more of the same -- better beats on the bottom line but revenues fairly uninspiring. Key reports we'll be watching: Masco (MAS:NYSE), Ford Motor (F:NYSE), Ralph Lauren (RL:NYSE), Eaton (ETN:NYSE), Clorox (CLX:NYSE), AIG (AIG:NYSE), Starbucks (SBUX:Nasdaq) and Southwestern Energy (SWN:NYSE). Union Pacific (UNP:NYSE), Johnson & Johnson (JNJ:NYSE), Best Buy (BBY:NYSE) and Texas Instruments (TXN:NYSE) will all hold analyst meetings, and that will be very enlightening. Retail sales figures by several individual companies will also be released.
Economic data will centered on consumer confidence, the Case-Shiller housing index, Chicago PMI, ISM manufacturing and the non-farm payroll report. Overseas, important data will be China's PMI, European PMIs, euro zone consumer confidence and Germany's unemployment and retail sales.
Apple (AAPL:Nasdaq; $604.00; 175 shares; 3.84%; Sector: Technology): The quarter was mixed -- better on the revenue line, driven by stronger iPhone sales, a miss on earnings and lowered guidance. We remain restricted on the shares but would be adding, especially under $600. The stock is down 13% from its high, and the company posted better iPhone and Mac sales, has new products coming (iPad mini, fourth- generation iPad, Mac refreshes) and has issued very low guidance. Margins are certainly disappointing on the guidance, largely tied to the new product introductions, currency and lowered iPhone 4/4S prices, but we believe there is a degree of conservatism. Trading at 9.5x ex-cash, the stock is very attractive here, and we moved it to a One. Our target is $700.
Bed Bath & Beyond (BBBY:NYSE; $57.45; 1,500 shares; 3.13%; Sector: Consumer Discretio
nary): Over the last several years, this has been one of the most consistent retail names in the group. Management has averaged comp-store growth at 3.3% over the past five years vs. a sector average of 1.4% and in the same period EPS growth has averaged 18%. This is why we started buying the stock when it was hit 9% after its last quarter on margin concerns. We believe the misstep was mainly a product of the Cost Plus acquisition, and we expect a quick rebound. We like the company's leverage to an improving housing market, and we believe the value driven by its Christmas Tree Shoppes will resonate with customers during the macroeconomic uncertainty. We added this week, as shares trade at 11.2x forward estimates, a 28% discount to their historical average. Our target is $72.
He is dead-on about BBBY, but there is one thing he didn't mention that is important.
Sadly, hurricane Sandy is going to force a lot of homeowners on the East coast into BBBY stores to replace belongings. It's the economic stimulous we didn't want, but someone always benefits from a tragedy.