Monday, December 17, 2012
‘Fiscal Cliff’ negotiators have reportedly made meaningful progress over the weekend as the last full week of trading before the Christmas holidays get underway today. While we are a bit light on the data front today, but the rest of this week brings a number of top-tier economic and earnings reports. But the focus will remain on the ‘Fiscal Cliff’ question.
Housing is a major component of this week’s data, with Tuesday bringing the December homebuilder sentiment index, Wednesday the November Housing Starts numbers, and Existing Home sales data on Thursday. The expectation is for Housing Starts to pullback modestly from the prior month’s level, while the homebuilder sentiment index is expected to be essentially unchanged from the month earlier level. Other major reports this week include the November Personal Income & Outlays and Durable Goods reports on Friday and the final read on third quarter GDP on Thursday. Expectations for GDP growth in the fourth quarter have been steadily coming down in recent weeks and currently stand a little under 1.5%, with the growth pace not much better in the first quarter of 2013 either.
Expectations for the back half of 2013 are for much higher growth pace, though it’s hard to envision how the momentum will shift. A Wall Street Journal report today quoting a Dow Jones Newswires survey shows major Wall Street firms expecting treasury bond yields to rise in 2013. Most prominent among these major brokerage firms are the 21 primary dealers, who underwrite treasury bond sales and deal directly with the Fed. The median 10-year Treasury bond yield forecast for the primary dealers is for a roughly 50 basis point rise by the end of 2013 – from the roughly 1.71% as of Friday’s close 2.25% by the end of the year. Yield on the same security was at 1.88% at the end of 2011.
This makes perfect sense, for two reasons. First, yields have been so low for so long that the only direction they should be moving going forward is – higher. Second, if anyone in the market has a good understanding of the Treasury bond market, it is most likely the firms that underwrite the securities – meaning the primary dealers. The only problem is that the primary dealers had come out with similar forecasts in 2011 and 2010, but unfortunately things turned out differently. May be the third time is the charm. But it’s not easy for anyone, even the primary dealers, to ‘fight the Fed’. With the Fed committed to adding more than a $1 trillion worth of treasury and mortgage bonds to its balance sheet in 2013, it is perhaps reasonable to be skeptical of Wall Street’s treasury yield forecast for 2013 as well.
These economic growth questions have a direct bearing on the corporate earnings outlook for 2013 as well. The fourth quarter earnings season gets underway this week with Oracle’s (ORCL) quarterly report after the close on Tuesday, though we are still a few weeks away from the ‘unofficial’ start of the earnings cycle with Alcoa’s (AA) release on January 8th. Other major reports this week include FedEx (FDX), Discover Financial (DFS), and Nike (NKE). Earnings expectations for the fourth quarter have been steadily coming down over the last three months, with total earnings expected to be up 1.2% from the same period last year. This is a sharp drop from the roughly 7% earnings growth expected just three months ago. But even as expectations for the fourth quarter have come down, we haven’t seen much downward adjustment to expectations for 2013, which still shows earnings growth rate of more than 10%.
The same thinking that is looking for the economy and treasury yields to start rising in the second half of 2013 appear to also at play in looking for 10%-plus earnings growth. May be it’s just me, but I find it hard to buy into these expectations.
Director of Research