S&P has tallied 203 company reports for Q1. The beat rate is 68% and the miss rate 22%, both among the best in several years. Per S&P estimates, Q1 earnings should reach $27.62, up 7.2% Y/Y and up $0.12 (0.4%) from last week and in line with the estimate at March 31. Q2 estimates have edged up from $29.64 to $29.72 which would be a sharp acceleration to a 12.7% Y/Y growth rate.
Factset’s tally totals 240 companies and 73% have beaten estimates, equal to Factset’s 4-year average.
Only last week, 76% of the 157 companies that reported beat estimates by a whopping 14.7% on average. Factset now calculates that Q1 EPS will be up 0.2%, from -2.0% last week.
In terms of revenues, 53% of companies have reported actual sales above estimated sales (4-year average: 58%).
Aggregators treat certain accounting issues differently. Varying treatments for pension expensing caused “operating” earnings to differ markedly since Q4’12. (S&P rightly treated them as operating). These issues should be tapering off this year. Nonetheless, Facstet’s tally for Q2 growth rate of 6.8% remains much lower than S&P’s 12.7%. The gap should be closing in the second half with Factset estimated growth rate of 10.4% compared with 14.1% for S&P. (I use the “official” S&P figures for valuation purposes).
The earnings profile for 2014 is becoming much more encouraging. Excluding unusual accounting issues mentioned above, the last time we got quarterly double digit profit growth rates was prior to Q4’11. During the following 9 quarters, quarterly earnings, normalized for pension expenses, have grown only 4.1% Y/Y on average.
With valuations 8% below the Rule of 20 fair value of 2008 (using trailing EPS of $109.15 after Q1), rising prospects of accelerating profits help reduce downside risks given that no recession is in sight. Incidentally, fears of margins mean reverting will need to be pushed out again. Both S&P and Factset calculations indicate that net margins will remain near their high in Q1’14.
Continued margin expansion is a crucial assumption here given that revenue growth is a low 1.5% through Q4’14. Almost all of the average 9.2% profit growth expected over the next 3 quarters needs to come from further margins expansion. Given flattening margins since Q1’13, this looks like a rather heroic assumption at this point.
That said, analysts have been rather conservative on their margins assumptions in the last 9 months. Q3 and Q4’13 margins came in at 9.5% and 9.7% respectively compared with estimates of 9.6% and 9.5%. Q1’14 margins were seen at 9.8% and S&P sees them at 9.75% mid-way into the season. Companies also do not appear too concerned by analysts estimates going forward:
At this point in time, 51 companies in the Index have issued EPS guidance for the second quarter. Of these 51 companies, 36 have issued negative EPS guidance and 15 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the first quarter is 70%. (Factset)
Factset says that this percentage is above the 5-year average of 65%. But it is much lower than anything we have seen during the last 5 quarters (lowest was 75.8% on Feb. 22’13 for Q1’13).
Analysts themselves remain confident on their forecasts. In fact, they have been raising their full year forecast in recent weeks.
The S&P 500 Index is up only 0.9% so far this year while trailing EPS are up 6.9% with generally stable inflation. Meanwhile, the Rule of 20 “Fair Index Value” (yellow line below) jumped 7.4% since the end of December, creating an 8% gap to Fair Value, the highest gap since mid-2013 when the S&P was in the 1600 range (see black rectangle on upper right corner in chart below). The recent spike in the Fair Index Value broke the flattish trend observed between mid-2012 and December 2013 when earnings growth slowed.
Is this a buying opportunity, just as we enter May (as in Sell in May…) while still in the Mid-Term Boom-Bust period?
- Technically, the next major resistance is the still rising 200-day moving average (1773), 5% below current levels. Eight percent upside to Fair Value vs 5% downside to the 200-d. m.a.. Not great but not bad, or vice versa…
- Revenue growth is tepid but margins are holding up with no recession in sight. On this, the best indicator remains the Conference Board LEI which remains very positive.
- Economically,
(…) the recovery is shaping up as one of the most enduring and is poised to outdo the average duration for recoveries since the end of the second world war. The US economy has expanded for 58 months in a row and based on most metrics, the expansion seems to have quite a bit of room to run. Despite the continuing effect of the 2007-2009 financial crisis on business and consumer spending and the emerging effect of secular stagnation resulting from low employment and productivity growth, the case for an imminent recession is very distant. The recession risk has a low 20% probability and all leading indicators are pointing up.
Moreover, the profitability rate of businesses, the utilization rate of industrial capacity and unemployment rate suggest that the US has not burnt enough of their excess reserves to derail the expansion. Recent data on consumer and business confidence show that the population is not worried. In fact, the unusually icy winter and its very bitter cold did not stop the economic expansion. The Palos’ economic model which is based on big data prints and high frequency data points shows that the GDP increased at the annual rate of 1.5% during the March quarter.
Accordingly, current economic and financial conditions are allowing the Fed to engineer a soft landing of its unconventional monetary stance. (…) (Hubert Marleau, Palos Management)
- The main economic risk is a sharp rise in inflation (see FACTS AND TRENDS: THE BIG WAGER).
Otherwise, Ukraine could become a game changer for Europe which, combined with the slowdown in China, would certainly impact the U.S. economy. Odds of further Russian “maneuvers” are very high and will likely weigh on equities for a while.
Getting more comfortable with equities is tempting given the current risk/reward ratio and the improving profit picture. The “externals” suggest continued restraint, however, until the Ukraine situation clears up and until we get more reassurance that inflation is not creeping up on us. Two other, frankly more personal, factors are influencing me at this time: the salmon fishing season is approaching and this:
Some recent research has shown that highly intelligent retirees—even those with no signs of dementia—find it harder to distinguish safe investments from risky ones. Compared with younger investors, those over the age of 65 “showed striking and costly inconsistencies” in their financial behavior, according to a study of 135 subjects led by Ifat Levy, a neuroscientist at Yale University who has conducted experiments on this topic. For example, older investors tend to make simple errors that younger investors avoid—and such problems only worsen with dementia. Those individuals who are elderly—but still mentally fit—maintain a healthy sense of caution when confronted with a complex or risky investment. But someone who has long made sensible financial decisions and is now declining cognitively is likely to remain self-confident “even if he has lost his reasoning capacity,” warns Robert Willis, an economist and professor at the University of Michigan who studies financial decision-making among the elderly. (Finances and the Aging Brain).
