Posts tagged ‘earnings’
One of the key themes this blog identified on the eve of 2014 was earnings growth. Equity valuations in the major markets had reached territory that needed to see a higher denominator in the p/e ratio or risk looking overvalued.
Since then we have seen a quarterly contraction in the US, patchy outcomes for GDP across the Eurozone and tax-related volatility in the Japanese economy. There has thus been reason to suspect that this growth would disappoint. And that is before considering any confidence impact from events in Ukraine, the Middle East and elsewhere.
So the Q2 US earnings season which opened in early July was arguably more important than most. When it opened, consensus expectations as followed by Bloomberg were for a 4.5% increase on the prior year, barely higher than the 4.2% increase in nominal GDP over the same period.
In early August, however, just as the S&P 500 had fallen back towards 1900, things were looking rather better. By this time the first 200 companies had reported their results. The increase in EPS was averaging 12%. The analyst consensus began to catch up, and the final outcome for Q2 was then expected to reach 8.2%.
Now the season is essentially over with 499 companies having reported. Index earnings for the S&P rose by 10.3% over the prior year. In price terms the 500 is up by more than 18% over the last 12 months, but supported by that bottom line growth the exuberance does not appear irrational – especially if most of the momentum can be maintained, as is expected.
There was an interesting story out this morning on European earnings growth too. With the sovereign debt crisis and the double dip recession, the outcomes for reported EPS on the Stoxx 50 have been dire. But for the first time since April 2012, there are now more positive than negative earnings revisions coming from analysts covering European stocks. In the words of one such:
“There are signs that the pressure on European companies … is beginning to abate. We’re beginning to see small upgrades in earnings estimates overall for the first time in absolutely ages.”
There is a connection here to recent euro weakness, and a further connection to the open mouth operations of the ECB. There is also a lot of ground to make up: simply stripping out reported losses reduces the historic p/e on the Stoxx to 16.1x from over 23x. For the S&P 500 this makes almost no difference – 18x drifts lower to 17.8x.
These markets are not a steal any more – in isolation, certainly. (Relative to bond markets they still look very cheap, but that says just as much about poor value in rates.) It has been a long wait for many to see real, underlying growth actually return to growth assets. What it needs to do now is continue.
Yesterday came the news that the US economy grew at a 3.2% annualised pace in the fourth quarter of last year. This encouraging sign came on top of Tuesday’s Q4 GDP data for the UK, which capped off the strongest year since before the Great Recession. Yet markets hardly noticed. Perhaps it’s the freak winter weather over the Atlantic, but January has got 2014 off to a bearish start.
At the time of writing the S&P 500, the FTSE 100 and the Euro Stoxx 50 are all down by 4-5% so far this year and the Nikkei has dropped by over 8%. Ten year yields in safe haven markets are about 0.3%-0.4% lower; Greek debt has sold off. Emerging market debt is weaker, and EM equity is also off, especially in Latin America. The trade weighted yen has strengthened for the first month since August, and the dollar has risen too. Highest profile currency losers have been Argentina and a few other EM nations. Gold is up; industrial metals, down. Credit spreads are wider.
Risk, in other words, is off again.
Explanations for this sorry start vary, as ever. There is a vague consensus that emerging markets are a problem, and talk of capital flight and current account deficits. Unfortunately this doesn’t quite add up though. Turkey saw its currency lose nearly 9% of its value against the dollar by the end of last week and yes, it runs a material current account deficit – 7.2% of GDP at the last count – but it hasn’t run a surplus since 2002, so it is not clear why this measure should suddenly assume overriding relevance. For that matter, the Russian rouble has fallen by over 7% against the dollar so far this year, and yet Russia has posted a current account surplus each quarter since the crisis of 1998 (amassing some of the most substantial reserve assets in the world as it did so). Then there is the other North American dollar. Yes, Canada also has a current account deficit – but nobody seems to be talking about that in relation to the 5.5% sell off worn by the poor old loonie. In fact, coupled with more moderate weakness in the Aussie dollar, the real currency story begins to look like US dollar strength with EM specifics a bit of a side-show. Though again, that might not square with higher gold.
The half-hearted media attention given to EM is understandable. There is no news like bad news: crises shift copy. Away from emerging-land, however, there are plenty of other discrepancies which have gone unnoticed. In the UK we have had real evidence of the extent to which stronger growth is good news for sovereign debt, and with recovery on the Continent picking up, Spanish and Portuguese bonds have outperformed German bunds in this month’s rally. Ten year Portuguese debt came within a hair’s breadth of knocking through 5% today and has made new post-bailout lows. And yet Greek debt, as we have seen, has sold off – while the Athens Stock Exchange has outperformed all major markets, currently standing a little higher on the year to date.
In the US, stock market weakness has been accompanied by earnings reports which have surprised to the upside 72% of the time. As of this afternoon 250 of the member companies of the S&P 500 index have reported EPS for Q4 and have managed a +10.5% share-weighted change on the year since Q4 2012. Both of these percentages compare favourably with the picture at the end of January 2013, a month which saw the S&P rise by more than 5%.
There is more that could be said along these lines but the picture is clear – which is to say, not very clear at all, and subjected to interpretations which barely convince even at a superficial level.
What can perhaps be observed is that 2013 saw some unequivocal behaviour from asset classes and that uncertainty has reasserted itself since. We should not expect markets to move in straight lines. Sometimes this sets them against the grain of the fundamentals – and that, of course, can present opportunities.
The US shutdown is over. Japanese inflation for the year to September reached its highest level for nearly 5 years. And UK GDP data showed signs of a strengthening recovery. The S&P 500 has risen 4% since the beginning of the month, the FTSE 100 has done likewise and the Euro Stoxx 50 is up by a little more.
At the same time, the Norwegian sovereign wealth fund – the world’s largest with $810bn under management – announced that it is waiting for a correction before increasing its equity exposure. (See the widely-read Bloomberg story here.)
Developed-world equity markets have had a strong 2013, to the point where it is difficult to argue on some measures, such as p/e ratios, that they offer value. Are we entering the territory of over-exuberance?
As a starting point let’s have a look at what the CEO of that Norwegian fund actually said:
Our share in the stock market has been stable or falling even though markets are rising, and that means in practice that we’re not using inflows to buy stocks … In general, we see market corrections more as opportunities than as threats, so it’s not something that worries us. If they come, that’s just a positive sign for us as an investor.
According to the interview he did say the fund was “preparing for a correction”. But this is a fund whose rapid growth is underpinned by sizeable petrodollar inflows. They are not selling the market, and in the event of a correction – should it come – they intend to start buying again. In fact this sounds like the Norwegian central bank is offering the market a put!
In addition it is always worth looking at what reported earnings are doing. US news has been dominated by political and monetary goings-on, but the S&P is almost half way through the latest quarterly earnings season: 243 companies have reported an overall EPS increase of 8.4% on the previous year so far, significantly ahead of expectations. If that growth rate can be sustained as predicted the current price level would soon look much easier to bear.
Finally, the rally in risk pricing has not been universal. We took a look at India a few weeks back when the rupee was coming under heavy pressure for instance. Indeed, emerging market equity in general has underperformed its developed-world equivalent by a margin of 23% over the year to date. Selective exuberance may be irrational in some ways but it is not so terrifying as indiscriminate (and price insensitive) optimism.
The Norwegian view looks sensible: no panic, nor any excitement over the major markets at current valuation levels, and a preparedness to buy again should prices come down.
The markets which have performed the most strongly – as ever – may not be offering the most obvious opportunities. But the steady stream of positive data on earnings and economies is encouraging for their investors nonetheless.
2013 has barely begun. With major stock indices some 3-5% higher already for the year to date it is obvious that it has begun with a bang.
Confidence has been improving for some time, taking valuations with it. At the end of the year the MSCI World Index of developed-world stock markets carried a historic p/e ratio of 16x. At the same time, consensus earnings growth for the index (based on analyst estimates aggregated by Bloomberg) is forecast to rise by 23% this year. If that can be delivered, current pricing doesn’t look too demanding.
Turning to the US in particular, as of today 67 S&P 500 index members have reported earnings for Q4 2012. Share weighted EPS are up 31% on the previous year. All that growth comes from financials: ex-financial EPS are currently down slightly (-0.4%).
Overall, earnings are forecast to have grown 3.8% on Q4 2011 by the time the last index constituent reports. Unsurprisingly that number has risen slightly since the data began to come in, and if the pace doesn’t slacken too suddenly will be revised up again.
There are a number of reasons why we might expect company earnings to do well – and to do better than nominal American GDP. Most obviously, there is room for margin improvement. Some of this may be attributable to manager brilliance; some is certainly attributable to new lows for corporate interest rates (with the BoA ML US Corporate Index recently yielding a record 2.7%), and lower effective tax rates over the last few years.
Whatever the reasons, however, EPS growth of 31% is remarkable. It appears highly unlikely to be sustained at that level as more reports come in. But even if we do see “only” 3.8% on the year to Q4, and similar data this year, robust earnings growth for the US and for the developed world as a whole begins to look perfectly plausible.
There are risks out there, as always. The sudden optimism over US politics and Japanese growth may be premature. It seems as if the European crisis is being disregarded now too. Though it has yet to push pricing into uncomfortable territory, there is the scent of complacency in the air.
After the disappointments of recent years we wish the relief rally well. Whatever happens to sentiment, sustained earnings growth would give it important support.
Shares have enjoyed a strong start to 2012. The MSCI World Index of developed country stock markets closed yesterday up 6.5% on the year so far. The Emerging Markets index has done even better, closing up 13.9%. And yet looking at the headlines one might think this overdone. Banks in particular seem to be suffering, with Deutsche Bank for example reporting a 76% collapse in profits only yesterday. Last year markets were arguably too pessimistic in the face of mixed economic data and robust corporate earnings growth. Could they be growing too bold at present and overreacting the other way?
Let’s look at the S&P 500 index. Fourth quarter earnings season in the US is well underway, with just over half the members of the index (273 companies) having reported as of yesterday. Earnings per share for those companies rose 3.5% on the quarter, falling short both of analysts’ estimates (+4.8%) and the 5.4% rise in the index itself. On the face of it this could be taken as a sign of over-optimism.
Digging a bit deeper, however, we find that if we exclude results from the financial sector – which has posted a fall in EPS of over 18% so far – non-financial companies have reported an increase in earnings of 8.2% (against a forecast of +6.5%).
What is important about this is that it is the big banks which were most exposed to last year’s market turmoil. If Deutsche’s investment banking division, for example, had broken even over the quarter instead of posting a €422m loss, profits across the bank as a whole would have beaten analysts’ estimates. We have seen similar stories in US bank results, where poor performance from the market-exposed parts of the business masked continued modest improvements in key bread-and-butter measures such as the size of provisions for loan losses.
Even if we choose to ignore this level of detail, however, stock market indices have a long way to go before they begin to look overvalued. For example, the p/e ratio of the FTSE 100 index has averaged about 14 over the last ten years. Even assuming earnings growth of zero, to match this valuation from the current p/e level of 10.4 would require growth in the index of some 35% – a rise in price to over 7,800.
Of course, it is still possible that some kind of catastrophic collapse will overtake us, and market valuations reflect that fact. But it is at least equally possible that calamity is avoided, that the world’s tortuous recovery continues its uneven path and that over time even the wounds of the banking sector will heal.
The rally in equities so far this year has been swift, and rather surprising. Based on what we know about the valuation of stock market earnings, however, it is too early to say that price levels have got ahead of the fundamentals.
A couple of months ago we had a look at US economic data and concluded that the market was taking an unequivocally pessimistic view of fundamentals that were actually mixed. To modify the famous characterisation, the glass appeared almost empty rather than half empty. And this week, two stories showed that the current market similarly sees the glass as half empty even when it’s almost full.
First, we had some data out from China on Tuesday. As expected, this showed that GDP growth on the year to the end of September had slowed, to 9.1% from 9.5% the previous quarter. That 9.1%, of course, is comfortably the highest growth rate of any major economy. It’s over twice what’s expected for the world as a whole. In dollar terms it will see China alone account for between a fifth and a quarter of global output growth this year.
At the same time, September data for Chinese industrial production and retail sales beat expectations by showing a modest acceleration over the previous month.
Needless to say, the market took the “GDP slowdown” very bearishly and ignored the rest of the data completely.
The second story, also out on Tuesday, concerned the micro rather than the macro picture: Apple announced its results for the fourth quarter, and earnings per share of $7.05 disappointed relative to expectations of $7.31. The disappointment attracted much comment and dragged on the wider market.
Less attention was paid to the fact that this level of earnings represented a 52% increase on the previous year. Nor did markets care that disappointing earnings have been the exception, not the rule, so far this season: as of yesterday, 117 members of the S&P 500 had reported earnings, and of those, 85 had beaten analysts’ estimates. Twelve month earnings growth for all 117 companies averaged +14.7%.
There are fundamental concerns out there. There will be bad news. But GDP growth of 9%, and earnings growth of 50%, isn’t it.