Friday, January 25, 2013
Stocks have made impressive gains lately, with the benchmark indexes sitting pretty at multi-year highs. This is prompting fresh money to pour into stocks in recent weeks, potentially reversing a persistent trend of the last three years. Driving this optimism is the sense that the economic picture is looking up and policy makers will be able to avoid obvious policy missteps. Many of us expected the uninspiring state of corporate earnings to put a brake to this emerging positive narrative, but that hasn’t happened either. So, where do we go from here?
Avoiding ‘Fiscal Cliff’ was a positive as is the recent deferment of the debt ceiling issue. Budget issues still remain, but the relatively greater clarity on tax issues as a result of the cliff deal has been reassuring enough. The Fed continues to remain supportive by deploying the full might of its balance sheet to keep interest rates low. The Fed balance sheet just crossed the $3 trillion mark, more than triple its size in 2008, and will likely reach $4 trillion by the end of the year.
Optimism on the economic front isn’t entirely misplaced either, particularly with respect to the U.S. and China. The domestic housing scene is clearly looking up, as today’s December New Home Sales numbers coming out a little will show. The knock on effects that the housing recovery will have on the economy could get a further boost if the trend in the last two weekly Jobless Claims readings is for real. Beyond the U.S. shores, the outlook for China has clearly changed, with nobody talking about the much dreaded ‘hard landing’ scenario any more. By some measures even the situation in Europe may not be as grim as this morning’s German business confidence survey shows.
On the corporate earnings front, investors are finding enough reassuring data points to sustain the positive momentum. Part of the earnings outperformance is due to lowered expectations that made it easier for companies to come out ahead. Just like this morning’s earnings beats from Proctor & Gamble (PG), Honeywell (HON), and Halliburton (HAL), we have positive earnings surprises from 63.9% of the 147 S&P 500 companies that have reported results as of this morning. Unlike the third quarter, the revenue picture doesn’t look that bad either, with 59.2% of the companies coming ahead of revenue expectations. But it’s not all just lowered expectations; company guidance has also been favorable, particularly relative to what we heard from management teams in the third quarter.
But all is not well on the earnings front, as growth has effectively flat lined. Total earnings for the 147 S&P 500 companies that have already reported results are up only +0.9%. The composite earnings growth rate, combining the results of the 147 that have come out with the 353 still to come, is for +0.4% only. This would mean that we will exit 2012 at an annual earnings growth rate of less than 3%. Expectations for 2013 suggest the growth pace picking up, particularly in the back half of the year, to a pace almost three times the 2012 level. I expected management teams to start anchoring 2013 expectations at more ‘reasonable’ levels on the Q4 earnings calls. But barring a few exceptions, we haven’t seen that yet. In fact, management teams are talking about positive signs out of China and stabilization in Europe.
What does all this mean? Perhaps the market’s recent price action is really reflecting favorable underlying momentum. Hard to buy into this narrative, but there may be some basis after all for all the positivity sloshing around us.
Director of Research
Friday, January 25, 2013