On October 9 we issued a Complacency Alert, warning that, contra The Wall Street Journal, weak earnings did indeed matter to stock prices despite QE3 liquidity injections by the Fed. The contours of third quarter earnings are about as expected, with Wall Street and other banks reasonably good relative to analyst forecasts while globally exposed cyclicals are reporting weak results. Big healthcare companies are reporting in line earnings, and companies like PPG with exposure to housing (paints) are doing relatively well. Housing exposed stock should continue to shine, relatively speaking.
However, both the overall tone of earnings and investor reaction to them are even more negative than we expected. A large and diverse group of multinationals have posted results that are mediocre or worse, including IBM, INTC, MSFT, VFC, CAT, MCD, DOV, DHR, APD, PH and GE. Look for similarly weak results from the industrial and chemical companies that report this week. There is some indication that September orders were weaker than July and August, probably because companies are increasingly worried about the “fiscal cliff.” CNBC reports that 90% of companies are cutting Q4 earnings guidance, which is consistent with our October 9 statement that “forward estimates will continue to drop.”
These results once again illustrate that “S&P is not GDP” because, inter alia, S&P is global not just domestic and is far more leveraged to manufacturing and exports. A modest improvement in U.S. GDP driven by stronger housing would not offset recession in Europe and weakness in emerging markets. So we see little reason to believe profits are now “troughing” and will soon strengthen:
- Though arguably the U.S. economy is improving slightly, it will continue to be quite weak even if Washington avoids going over the “fiscal cliff.” Recall that Republicans and Democrats agree that one significant tax cut, the reduction in the Social Security payroll tax, should end on January 1. And on that day Obamacare taxes will start to hit Americans who make too much money. If Obama wins business will worry about a renewed regulatory onslaught, which will discourage capital spending and hiring.
- With Europe’s banks and governments deleveraging, we see little reason why Europe will quickly and decisively pull out of recession. Decision makers continue to be reactive not proactive; it takes financial crises to scare them into moving forward on fiscal integration and banking reform. For example, friendlier bond markets are allowing Spain to delay asking for a bailout from the ESM. Whether in the Street or at the polls, citizens may revolt against the elite’s ruinous policy of recession cum fiscal austerity.
- The situation in China and other emerging markets is opaque, but these economies are fairly dependent on exports to “developed markets” and on commodity prices—neither of which will be strong next year. Even if effective policies are pursued, it will take quite a while to shift China from an export-oriented to domestic-demand footing.
We expect Street analysts to slash their 2013 earnings estimates over the next six months, bringing the 2013 “bottom-up” S&P 500 EPS estimate down from $116 recently to around $106, which would only represent a 5% gain from $101 in 2012. According to Barrons data, in early September Wall Street strategists’ median “top-down” 2012/2013 EPS estimates were $102.25/$108.
