We are two-thirds into earnings season. The stats are getting more meaningful, though not necessarily better.

S&P officially has 343 reports in, 65% beats and 23% misses. Importantly, estimates keep coming down. Q4’12 EPS are now seen at $23.53 ($23.83 last week), Q1’13 at $25.71 ($25.86) and Q2’13 at $27.53 ($27.62). The magic of rising markets and upbeat economic expectations is keeping full year 2013 estimates essentially intact at $111.36 ($111.50). That is in spite of the fact that Q4’12 earnings will be down 0.8% Y/Y and down 2.0% Q/Q.

IT companies are handsomely beating estimates (82%). Ex-IT, the beat rate drops to 62%. Ex-Financials (69% beat rate), the ex-IT, ex-Fin beat rate is 59.8%.

S&P 500 companies’ revenues are estimated at $285.43 in Q4’12, up 4.7% Y/Y, much better than the 1.1% growth rate in Q3 when 3 sectors had negative growth rates (Energy, Materials and Utilities).

Margins have finally declined, being expected to total 8.2% in Q4, down 46 bps Y/Y. A big part of the decline comes from higher pension expenses (see EARNINGS: Pensions Costs Begin To Bite) which many aggregators, such as Moody’s, seem to consider non-operating (wrong). What is interesting from Moody’s table below is that ex-Financials, earnings growth drops from 9.6% to 4.1%, although I fail to see how they got +9.6% in the first place.


To be sure, Q4 data is very messy, partly due to pension expenses, partly to volatile commodity prices. This table draws from S&P data and takes account of increased pension expenses.


S&P 500 Index trailing 12-month EPS are now seen at $97.20 after Q4’12, down from $97.50 last week, and from $97.40  three months ago. As I wrote recently, the reality is that quarterly earnings have been stable since Q2’11 and trailing 12-month EPS peaked in Q2’12. To repeat myself:

Equity values have little back wind to advance “naturally”, unlike 2009-2012 when earnings were rising sharply and inflation declined. Until earnings rise again, equities need investor enthusiasm if undervaluation is to be narrowed, a pretty fickle ingredient if there is one.

The undervaluation of the S&P 500 Index is currently 15% as the Rule of 20 fair value is 1778. The 1500 barrier has been traversed and we are within sight of the 2007 peak of 1570 which will undoubtedly excite the talking heads.

By the way, if you care (I only do because he has been a pretty good contrary indicator), Nouriel Roubini tags equity markets as “rightly buoyant”:

“When you look at the [mixed] economic data, there’s a gap between the fact that the markets, rightly so, are buoyant,” he told the network, “because middle of last year central banks had done another massive round of quantitative easing.” (CNBC via

The über-bear ZeroHedge never misses a moment to ridicule bullish talking heads:

Six years ago today, with the S&P 500 around 1460 – having risen 20% without a correction for seven months – a handful of Wall Street’s best and brightest joined CNBC’s Larry Kudlow and Bob Pisani to discuss the Goldilocks economy, why the bears are wrong, and where the market is going next. Sometimes, we just need a reminder to snap us out of that recency bias… for example, Bob Pisani: “We have got a global rally going on… and the important thing is… there’s a floor to the market – every time, for the last seven months, they sell the market down for 2 days, it comes right back.”

Ralph Acampora: “I’m bullish, but I don’t think I am bullish enough…there’s new leadership”

Larry Kudlow: “Goldilocks kicks some more butt and the bears of the last four years are wrong… as they climb the ‘wall of worry'”

Bob Pisani: “Transports have been rallying – as the disaster that the bears keep talking about hasn’t happened… When you are in a global expansion like this, to sell…is foolish.”

and our favorite:

Bob Pisani: “People who keep talking about this real estate bubble don’t understand… there are 3 things that bring down real estate markets: 1) the economy falls apart, 2) liquidity is withdrawn, and 3) supply overwhelming market – NONE of that has happened.”

This is why we must always keep sight of both the upside potential and the downside risk.


Upside to fair value is +17%.

The first downside risk is technical: the 200 day moving average is at 1405 (-7.4%), but rising. The second risk is that deep pessimism returns and undervaluation retreats to the mid-2012 level of -25% (1333, -12%), not totally unlikely given the many economic uncertainties remaining, the difficult financial situation in the U.S. and Europe and the messy politics just about everywhere.

Some may find comfort in the fact that analysts remain upbeat with Q1’13 estimates +6.1% Y/Y. Expected growth is accelerating smartly as the year progresses: +8.3% in Q2, +18.1% in Q3 and a whopping +26.3% in Q4. Equity markets can feed on these hopes for a while but there is ample room for disappointment.

Indeed! Factset reports that:

In terms of preannouncements, 63 companies have issued negative EPS guidance for Q1 2013, while 17 companies have issued positive EPS guidance.

Let’s see the trend this earnings season:


It is important to realize that flattish earnings provide little backstop if investor sentiment turns down. Much like a windless sailboat seeking strong currents to move along, equity markets now need higher multiples to advance, a bigger bet than when earnings are fueling the engine. For now, investors seem hopeful, encouraged by:

  • a better housing market;
  • better employment numbers;
  • accelerating bank loans;
  • better news from China;
  • better second derivatives from Europe.

Yet, sentiment can change overnight. Consider these mood changers:

  • the ongoing fiscal drag hurts spending;
  • higher oil prices hurt spending;
  • the sequester hurts spending;
  • Europe keeps sinking;
  • U.S exports get hit;

The five positives are well known; the five potential negatives are not.

The 17% upside potential still outweighs the -7% technical downside risk more than 2:1 (assuming sentiment stays reasonably good…). Interestingly, under current conditions, at 1570 the upside to fair value would be 13% while the technical downside would rise to 10%. Such more balance risk/reward ratio could be a strong barrier.

I am keeping my equity light green, for now, but I am getting more nervous, carefully watching the current.



  1. interesting comment from John Hussman’s weekly report…

    As a sign of how warped this celebration has become, Gordon Chang appeared on CNBC on Friday, noting the troubling difference between exports reported by China to other countries and imports reported by other countries from China, as well as the inconsistency between low cargo numbers and high reported export numbers. In response, the CNBC anchor said – and I am not making this up – “You know Gordon, I agree with you, but let me take a different tack on this, alright? Let’s say you believe that China is making up the numbers. But if the stock market there keeps going up because of it, and you believe the government will keep priming the numbers, isn’t that sort of a reason to bet on the Chinese stock market?”

    If you watch the Gordon Chang link, he used S Korea as the example, with China reporting +6% exports to S Korea (I think) and S Korea reporting -4% imports from China (I think). Scary.

    Would be interesting to know similar numbers for the US and Europe, since they are the two big export customers for China.

    Thanks for the excellent work as always.

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