With newsflow fairly thin, Congress now idly prepping for a replay of December’s fiscal debate in February, the media searching for its next, post-Cliff myopic focal point, and econ data flow light, we thought we’d take a quick look at where we are as we head into earnings season.
Our quantitative outlook and the preponderance of domestic and global macro data has us sticking with our #GrowthStabilizing view while we continue to monitor the Top 3 Risks to being in equities at current prices – Rising Oil Prices, Japan, & #EarningsSlowing. As it relates to the 3rd point, below we highlight revision trends/sentiment, growth and margin comps, and quality of earnings trends for the SPX as we head into 4Q12 earnings season and 2013.
SPX Aggregate Comparables
Topline Comps: 4Q12 has a reasonably hard comp, after that the growth compares ease through 3Q13. Consensus estimates over the next four quarters show modest acceleration on a Y/Y basis thru 2013. On a 2Y basis (normalizing for comp volatility) growth estimates continue to decelerate thru 3Q13. In isolation, modest growth estimates and easing growth comparisons on both a 1Y and 2Y basis sets up neutral-to-favorable within the context of growth stabilizing and leaves some headroom for revenue beats should economic activity & real growth accelerate.
Operating Margins: EBIT Margin Comps remain modest in aggregate over the next four quarters with TTM operating margin changes running flat-to-negative. While the comp setup isn’t particularly challenging we would note that we remain at the top of the corporate margin cycle. After the multi-year run of margin expansion into and out of the great recession, any residual juice left in efficiency gains and headcount reductions has been largely exhausted. Wage inflation has been running negative on a real basis and with commodity costs down ~2% y/y on the quarter, input costs don’t appear to hold any particular upside here. In short, the mean reversion risk for margins remains asymmetrically to the downside with earnings negatively levered to topline trends – a dynamic that is likely to remain in place over the intermediate term.
Earnings: EPS compares mirror topline trends, easing sequentially over the NTM. Bloomberg Consensus is currently expecting a modest sales recovery in conjunction with margin re-expansion to drive a re-acceleration in earnings growth on a y/y basis. On a 2Y basis, consensus expects flat growth thru 3Q13. On balance, while we would be skeptical of the view that modest topline improvement can drive material operating leverage at this point in the cycle, the expectation for flat growth on a 2Y basis sits as a relatively neutral setup, in our view.
Other Comp Considerations:
- 4Q12: Mgmt will have the crutch of Sandy & fiscal cliff related uncertainty to lean on if results disappoint. The externalities in the quarter along with the legislative event catalysts just ahead on the timeline offer an easy out for mgmt and investors to dismiss or look past (now rearview) 4Q results
- 2013 Guidance: Initial guidance will be fluid and ranging (particularly in sectors like Healthcare & Defense) as managements attempt to handicap the fiscal policy outcomes of the debt ceiling and sequestration negotiations in February. The uncertainty also offers management any easy avenue for low-balling estimates and conservatively managing expectations.
- 1Q13: 1Q13 faces a particularly tough comp stemming from favorable weather in 1Q12 and in terms of working days due to Leap Year & the Easter shift. For those companies levered to weekday traffic/volume, working days shift to a small tailwind in 2Q/3Q13
Revision Trends: Sentiment has recovered off the early 4Q12 lows but topline growth estimates remain modest. Aggregate NTM Revision Trends across the SPX saw their most expedited drawdown since late 2008 post the conspicuous growth slowdown and the guide-down torrent that characterized 2Q12 earnings. Revisions chased guidance lower out of 2Q & subsequently chased prices higher into November only to be stiff-armed by a further deceleration in growth in 3Q12 alongside resurgent EU sovereign concerns and the uncertainties and prospective growth consequences associated with the debt ceiling and fiscal cliff issues.
Estimates have stabilized into year-end and are likely to track sideways over the next couple months as investors tread water moving through earnings and the debt ceiling/sequestration event catalysts that will peak in late February. On balance, expectations have rebased and the hurdle on sentiment isn’t particularly high given the weakness of the last few quarters the ongoing, prevailing fiscal policy uncertainty.
Examining the historical, temporal trend in annual estimates over the last few years reveals some consistencies. Generally, new year optimism and favorable seasonal adjustment factors within the reported economic and employment data support growth estimates through 1Q. As the mismatch between the optimism embedded in early year expectations and real and reported growth in 2Q/3Q emerges - due to inflationary, growth slowing impacts of fed policy initiatives and the reversal of seasonal adjustments in the data - expectations get tempered and growth estimates fail to confirm their early year exuberance. We’ll see if 2013 breaks the trend – while the impacts of seasonal adjustments in the reported government data will be largely the same as previous years, the debt ceiling/sequestration uncertainty will likely weigh on estimates and the Fed appears largely impotent here in regards to accelerating balance sheet expansion.
Earnings Quality: A quick-quant means for assessing quality of earnings is to look at the distribution of beats/misses clustered around the zero line. The Spread between companies missing by a small margin and beating by a small margin should be fairly normally distributed (or skewed modestly positive). If the spread moves excessively positive its an indication that managements (in aggregate) may be more involved in messaging earnings by managing accruals to get to the number.
Below we looked at the Spread between the number of companies beating estimates by less than 3% and the number of companies missing estimates by less than -3%. The longer term quarter-to-quarter trend is somewhat equivocal (& complicated by big event impacts) but its interesting to note that the spread is again beginning to rise over the last few quarters as sales growth has slowed & margin levers are largely exhausted. Something to keep an eye on as not all “E’s” in P/E are created equal. We’ll also take a comb through our aggregate SPX financials to look at cash vs. accrual earnings trends as well.
Christian B. Drake