The second quarter S&P 500 bottom-up EPS estimate is around $27.00 and should creep higher during the rest of earnings season. This is consistent with strategists’ full-year 2013 estimates of $108-110. Results are not great but good enough for stocks to keep grinding higher, barring an exogenous shock. Bears can find plenty to criticize in Q2 results, but I don’t find the critiques persuasive. Yes, the positive surprises so far have been dominated by financials, but so what? I don’t recall investors saying in the summer of 2008, “Well profits aren’t so bad if you ignore financials.” Yes, revenue is weak, but keep in mind that the weakest sector is energy, where revenue does not mean that much to investors; most other sectors are up low-single digit despite a strong dollar that is shaving about 2% off of multinationals’ revenue. Yes, big tech companies mostly missed, but this has less to do with a dismal global economy than market share losses of incumbent players such as MSFT, INTC, ORCL, and IBM, to new technologies.
Results of well-managed multinationals such as Coca-Cola and McDonalds underscore the global economy is weak from Shanghai to Stockholm. Nevertheless, quite a few big bellwether non-financials posted earnings that were acceptable or strong—in many cases better than over the past few quarters. I am thinking of JNJ, BAX, GE, UNH, UTX, HAL, DD, HON, SLB, WHR, LMT, DOV, JCI, TXN, and GWW. There is no evidence that the underlying momentum of earnings is worse in Q2 than over the past couple of quarters.
S&P 500 profits should continue to rise next year from, say, $109 in 2013 to $116 in 2014. Share buy-backs can continue to contribute 150-200 bps of that that 6.6% increase. Admittedly, the macro outlook is mixed at best. There is downside risk in China, and even if Europe is bottoming out demand will stay very soft for the next few quarters. As I have been highlighting for over a year (and as delay of Obamacare’s employer mandate underscores) Obama’s anti-capitalist onslaught (remember “You didn’t build that”?) continues to throw a wet blanket on the economy. His latest salvo is the attack on coal. And I won’t be shocked if he shoots down the Keystone XL pipeline, potential source of hundreds of good-paying blue collar union jobs.
Nevertheless, the U.S. has legitimate growth drivers, including housing, autos, and domestic energy production. We won’t have big tax hikes in 2014 as we did in 2013. And next year comparisons will be easier for certain big cyclical that have already been hit by the weakness in China; for example, this year CAT earnings will drop about 21% and FCX 17%.
What does all this mean for stock prices? They probably trend higher, though not in a straight line. As we have seen in the valuation junk bonds and high-dividend-yield stocks, investors are “reaching for yield.” With the payout ratio still low at about 32%, S&P 500 dividends are likely to rise faster than earnings, and investors will pay up for payouts. If the PE ratio were stable and the S&P 500 earned $116 in 2014, the index would be at 1800 a year from now. If the PE climbs half a point to 16x, the index will be at 1850, implying a price gain of 9.5% and a total return of nearly 12%. Not bad in a world of 2.5% bond yields and return-free money market funds. But expect some volatility along the way.
Copyright 2013 Thomas Doerflinger. All Rights Reserved.
