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Takeaway: Relative to the latest reported data, the macroeconomic outlook and mico-level trends, NTM EPS estimates remain dramatically inflated.

SUMMARY BULLETS:

  • Roughly 96% of the way through the Q3 earnings season, 58.7% of S&P 500 companies have missed on the top line and 30.7% have missed on the bottom line (478 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. If the season wraps up as things currently stand, 3Q12 will have reported the lowest percentage of companies beating on the top line since 1Q09.
  • 72% of companies that have issued 4Q12 EPS guidance have issued projections below the mean EPS estimate. That compares with a ratio of 80% on the negative side at this time during the previous earnings season. Despite this improvement, we continue to warn that consensus estimates for 4Q12 and 2013 remain dramatically inflated relative to any reasonable economic GROWTH scenario.
  • Bloomberg consensus still has S&P 500 constituent EPS growing an average of +7.1% YoY per quarter over the NTM vs. +0.9% YoY in 3Q12 and a trailing four quarter average of +3.1% YoY. While down from a projected quarterly average NTM EPS growth rate of +9.9% YoY when we first called out consensus’ poor modeling technique back on OCT 8, we still contend these estimates remain out to lunch with respect to any reasonably objective estimate of future corporate profit growth stemming from Bayesian logic.
  • One of the biggest proactively predictable fundamental risks to EPS growth we continue to see domestically is corporate cost cutting. Already, we’ve seen business investment contract at a -1.3% seasonally-adjusted annualized rate in 3Q12, the first sequential decline since 1Q11. Per a recent WSJ report, half of the 40 largest publically traded companies have announced plans to “curtail capital expenditures this year or next”.  
  • Equity bulls remain hopeful that this round of EPS engineering is more akin to the early 2004 and early 2011 slowdowns, rather than the early 2001 and early 2008 CapEx slowdowns, which brought forth the last two major declines the corporate profit cycle.  

WHERE WE STAND

Roughly 96% of the way through the Q3 earnings season, 58.7% of S&P 500 companies have missed on the top line and 30.7% have missed on the bottom line (478 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. If the season wraps up as things currently stand, 3Q12 will have reported the lowest percentage of companies beating on the top line since 1Q09.

From a growth rate perspective, S&P 500 constituent revenue growth slowed to +2.2% YoY in 3Q12 on a median basis from +2.7% YoY in 2Q12. S&P 500 constituent operating margin growth accelerated to +16bps YoY in 3Q12 from +2bps YoY on a median basis. From a forward-looking perspective, S&P 500 constituent sales growth is projected to average +4.1% YoY on a median basis, per quarter, over the NTM, while operating margins are projected to expand an average of +97bps on a median basis, per quarter, over the NTM. Both growth rates suggest marked accelerations from the latest trends over the intermediate term.

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - SPX Revenues

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - SPX Margins

WHERE WE’RE HEADED

Continuing our peak into the future, 72% of companies that have issued 4Q12 EPS guidance have issued projections below the mean EPS estimate. That compares with a ratio of 80% on the negative side at this time during the previous earnings season. Despite this improvement, we continue to warn that consensus estimates for 4Q12 and 2013 remain dramatically inflated relative to any reasonable economic GROWTH scenario.

Bloomberg consensus still has S&P 500 constituent EPS growing an average of +7.1% YoY per quarter over the NTM vs. +0.9% YoY in 3Q12 and a trailing four quarter average of +3.1% YoY. While down from a projected quarterly average NTM EPS growth rate of +9.9% YoY when we first called out consensus’ poor modeling technique back on OCT 8, we still contend these estimates remain out to lunch with respect to any reasonably objective estimate of future corporate profit growth stemming from Bayesian logic.

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 3

Shockingly, Bloomberg consensus is not out to lunch with their US and Global GROWTH estimates for 2013; this strongly supports our belief that bottom-up analysts are uniformly praying for a dramatic acceleration in stock buybacks, M&A and USD debauchery.

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 4

Not that gaming sell side analysts is a new strategy, but we must never forget that the sell side is paid to hope now and blame macro later when it comes to modeling bottom up estimates. Conversely, we will continue to use a rigorous top-down approach to front-run proactively predictable fundamental risks.

One of the biggest proactively predictable fundamental risks to EPS growth we continue to see domestically is corporate cost cutting. Already, we’ve seen business investment contract at a -1.3% seasonally-adjusted annualized rate in 3Q12, the first sequential decline since 1Q11. Per a recent WSJ report, half of the 40 largest publically traded companies have announced plans to “curtail capital expenditures this year or next”.  Equity bulls remain hopeful that this round of EPS engineering is more akin to the early 2004 and early 2011 slowdowns, rather than the early 2001 and early 2008 CapEx slowdowns, which brought forth the last two major declines the corporate profit cycle.  

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 5

This we know: corporate profits are, in fact, cyclical. We also know that corporate margins have been asymmetrically stretched to all-time peaks. The latter suggests to us that any further “improvements in corporate efficiency” are heavily skewed towards being a drag on future top line growth for the cost-cutting company, as well as a contemporary drag on top line growth for companies in the respective supply chain(s). As we’ve remarked in recent notes: broader economic growth suffers when corporate executives shift their focus en masse to playing “pin the tail on the EPS estimate” by embarking on aggressive cost-cutting strategies to appease shareholders (many of whom happen to be corporate executives themselves).

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 6

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 7

In the absence of robust top line growth, we submit that corporate executives can and will continue to pull various levers to get themselves and other shareholders paid. The risk, however, is that their micro-level tactics risk perpetuating a global economic slowdown initially brought on by a bleak macro environment and outlook. Keep that in mind when you press management teams on how they plan to “hit the numbers” over the intermediate term.

WHERE WE’VE BEEN

This is the third installment of our analysis of the 3Q12 earnings season. Please see below for the previous reports, as well as our initial #EarningsSlowing presentation as introduced as part of our 4Q12 Macro Themes:

  • OCT 8: Hedgeye’s Q4 Macro Themes Presentation
    • #EarningsSlowing - Corporate margins are stretched on numerous metrics. Even with financial engineering we suggest there's limited upside in the results from here.  We expect the gravity of global growth slowing and inflation accelerating to impact consumer and corporate P&Ls alike.
    • Bubble #3 - Following the tech and housing bubbles, the charts of Bernanke's Commodity Bubble could not be more crystal clear. So when does this bubble pop?  We'll continue to take our cues from the U.S. Dollar and weigh the influence of policy and fundamentals across the complex.
    • Keynesian Cliff - We wrap together an analysis of the U.S. Presidential  race with the nearing US fiscal  cliff. We discuss the impact of investors potentially shifting their attention away from  Europe and back to the U.S.'s ugly imbalances.
  • OCT 10: #EARNINGS SLOWING UPDATE: IS CORPORATE COST-CUTTING COMING BACK WITH A VENGEANCE?
    • As we have stressed in recent weeks, the 3Q12 earnings season will likely be the most dour since the Global Financial Crisis and, perhaps more importantly, consensus estimates for NTM EPS growth are simply too rich – particularly in light of aggressive margin assumptions embedded in consensus expectations.
    • As such, the direction and tone of corporate guidance will likely be as important to stock performance as it has ever been in the post-crisis period. In this regard, the next few months will definitely be a stock-picker’s environment for those seeking to meet year-end performance targets.
    • As we highlighted in recent notes, a key risk that could equate to an incremental drag on global growth over the intermediate term is an acceleration of corporate cost-cutting initiatives across both domestic and international corporations. Moreover, recent company commentary suggests this trend is already underway.
  • NOV 5: A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET
    • Roughly 80% though earnings season, it’s clear to see that 3Q12 has shaped up exactly as we had laid out in our #EarningsSlowing theme: very bad.
    • Consensus remains out to lunch with their forward revenue, operating margin and EPS growth estimates. When you combine the negative trend in corporate guidance with the potentially-precarious Global Macro setup (potential US recession; no Chinese stimulus; Europe continues to contract), it’s easy to anticipate a scenario whereby those estimates have to be revised down hard and fast at some point over the intermediate term.
    • Aggressive estimates for operating margin expansion puts a great deal of pressure on corporate management teams to accelerate material cost-cutting initiatives like we’ve seen at UBS, DOW, AMD, RIO, FDX and CMI (to name a few). While that may appear good for a single company’s earnings outlook in the short term, the reality is that when corporations are engaged in cost-cutting en masse, GDP growth tends to slow materially; this perpetuates top line weakness across the corporate sector in a reflexive manner.

Darius Dale

Senior Analyst