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Still Ugly, But Rate of Decline Slowing

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Highlighted stocks include Bristol-Myers Squibb Co. (BMY - Free Report) , Merck & Co. (MRK - Free Report) and Schering-Plough Corporation (SGP).


Key Points:

  • Still heading south with 2009 expectations falling 0.8% last week, but the rate of decline is slowing
  • 2009 expectations down 12.1% over the last month, 2010 down 7.6%
  • More than 1/3 of all 2009 mean estimates are down more than 10%, 8.8% down more than 50% over the last month.
  • Total net income in 2009 now expected to fall 11.8%, following 13.4% 2008 decline
  • Fourth-quarter reports have been ugly with total net income total net income 35.0% below a year ago. After all companies report, net income likely to be down 33.8%.
  • Financials red ink $18.1 billion versus $9.6 billion black ink last year
  • Excluding Financials, total earnings down 19.0% so far
  • Surprise ratio is running at 1.74:1 and the median surprise is 2.44%; both are below "normal"
  • Bottom up estimate for S&P 500 now $63.64 in 2009, down from $64.15 a week ago: I think we will be lucky if it is over $55.

Total Net Income Growth

The earnings picture still remains very ugly, but the good news is that the rate of decline has started to abate. Over the last week, the bottom-up estimate for S&P 500 (SPX) earnings declined "only" 0.8% to $63.64. In the previous week it was down 1.5% and in the week before that, it was down 2.2%. Over the last month, it is down 12.1%. Even 0.8% per week is still pretty scary if it keeps up at that rate, but it is sure better than seeing declines of over 2% per week.

We are almost done now with fourth-quarter earnings season with 409 companies having reported.

The season has been by almost any measure an extremely weak one. Looking at just those that have actually reported, total net income is down 35.0% and the median EPS growth is -7.8%. The remaining firms are expected to see their total net income fall by 18.3%, so assuming they come in exactly as expected, on a combined basis earnings should be down 33.8% for the quarter.

The weakness has been very widespread, with only two sectors, Health Care and Consumer Staples, reporting higher net income than a year ago. Both of those sectors are notable for their lack of economic sensitivity.

At the other end of the spectrum is the Financials, which are collectively gushing red ink as if they had severed an artery. Reported financial companies have collectively lost over $18 billion for the quarter, while a year ago they earned over $9.5 billion. Even that seriously understates matters since some of the firms which suffered the worst losses were acquired at the end of the year. As such they were dropped from the S&P 500, but their results were not included in the results of the acquiring companies. You might have heard of them - Merrill Lynch, Wachovia, and National City.

Aside from the Financials the worst hit have been the economically sensitive Materials and Consumer Discretionary sectors, which reported total net income down 81.9% and 64.0% respectively. There are not enough Materials stocks remaining to seriously change the picture for that sector, but the Discretionary sector still has quite a few names out, mostly retailers. If they report as expected, the sector will be down over 90% on a total net income basis.

Looking ahead to the first quarter, the expectations continue to deteriorate, and currently total net income is expected to be 32.7% lower in the first quarter of 2009 than it was in the first quarter of 2008. However, just last week the decline was "only" expected to be 31.2%.

As I have said many times before, it is more important to look at the trends than the levels when using earnings expectations data. This trend is screaming that the first quarter will be worse than the fourth, even though the currently expected level is not quite as bad. Also, every sector is expected to post lower total earnings. For 7 sectors, the rate of decline will be faster than in the fourth quarter. The 3 exceptions are the 3 worst for the fourth quarter.

Somehow I don't find earnings being down by 2/3rds instead of by 4/5ths all that comforting. That being said, it is worth noting that in every sector, the earnings growth is expected to be either positive, or less negative for the full year 2009 than it is for the first quarter. This suggests to me that many analysts are still holding out hope for that elusive "second half recovery". While hope is a good thing, especially from a spiritual perspective, it needs to be based on something in the realm of finance. There is very little in the economic data that I can see that supports this hope.

Total Net Income Growth (Reported)
Sector Q2 '08 A Q3 '08 A Q4 '08 A Q1 '09 E 2007 A 2008 A 2009 E 2010 E
Health Care 8.91% 6.60% 8.16% -3.23% 19.58% 9.12% 0.71% 10.71%
Cons.Stap. 0.08% 12.49% 5.61% -14.99% 6.02% 9.66% 5.26% 6.51%
Utilities 10.01% -9.65% -1.81% -3.52% 9.42% 2.12% 0.66% 10.35%
Telecom 6.15% -8.14% -10.21% -24.75% 25.68% 2.46% -16.39% 6.62%
Industrial 5.71% 0.16% -21.15% -31.87% 9.85% 1.14% -19.08% 8.22%
Technology 17.96% 8.21% -24.28% -35.84% 13.26% 15.07% -17.97% 20.92%
Energy 14.84% 57.27% -25.45% -53.92% 8.48% 19.34% -46.78% 34.15%
Cons. Disc. -21.98% -28.80% -64.00% -51.71% 0.69% -27.19% -1.39% 50.29%
Materials 5.15% 3.84% -81.87% -67.92% 11.62% -9.36% -44.03% 42.66%
Financials -47.26% -64.80% -288.57% -44.48% -16.36% -70.11% 45.16% 65.00%
S&P -5.35% -4.13% -35.01% -33.43% 4.08% -8.81% -14.07% 23.16%

Total Net Income (Reported)
Sector Q4 '08 Q4 '07 Q3 '08 Q3 '07
Health Care $25,116 $23,221 $25,369 $23,799
Energy $23,274 $31,220 $42,371 $26,942
Technology $22,961 $30,324 $26,278 $24,284
Industrial $18,709 $23,726 $22,375 $22,340
Cons.Stap. $18,064 $17,104 $20,202 $17,958
Telecom $6,029 $6,715 $6,219 $6,770
Utilities $4,109 $4,185 $6,214 $6,878
Cons. Disc. $3,301 $9,171 $7,330 $10,295
Materials $1,012 $5,582 $6,534 $6,293
Financials ($18,061) $9,578 $13,543 $38,477
S&P $104,515 $160,824 $176,436 $184,036

Total Net Income Growth (Not Reported)
Sector Q2 '08 A Q3 '08 A Q4 '08 E Q1 '09 E 2007 A 2008 E 2009 E 2010 E
Financials 7.19% -13.23% 34.55% -40.95% -20.40% 20.31% -12.55% 14.45%
Utilities 6.33% 24.04% 25.29% 1.41% 25.97% 2.57% 12.84% 18.89%
Health Care -9.83% 4.59% 14.97% -5.36% 14.12% 4.70% 6.16% 10.26%
Cons. Stap. 21.04% 24.44% -4.25% 2.20% 19.64% 22.24% 5.47% 11.08%
Telecom 30.87% 44.41% -5.46% 5.97% 21.86% 32.88% -6.96% -9.09%
Industrial 32.12% 47.69% -32.20% -33.60% 16.04% 19.78% -31.52% 25.29%
Technology 50.19% -33.08% -39.14% -55.75% -21.87% 31.58% -15.41% 19.91%
Energy -107.71% -76.02% -90.53% -79.98% 1.63% -89.46% -3.23% 591.19%
Materials -57.35% -78.84% -92.03% -76.49% -19.78% -69.41% -57.42% -25.27%
Cons. Disc. -109.05% -315.87% -130.93% -127.68% -31.44% -173.52% -146.69% 1.06%
S&P -57.27% -85.00% -18.34% -23.30% -4.18% -56.05% -71.39% -77.60%

Total Net Income Growth (Not Reported)
Sector Q2 '08 A Q3 '08 A Q4 '08 E Q1 '09 E 2007 A 2008 E 2009 E 2010 E
Financials 8.84% 7.07% 8.60% -3.09% 19.76% 8.93% 1.05% 10.96%
Utilities 2.04% 13.45% 4.54% -13.24% 7.23% 10.91% 5.28% 7.01%
Health Care 4.11% -5.99% 2.87% -4.01% 10.62% 2.80% 2.14% 10.33%
Cons. Stap. -1.11% -15.97% -18.29% -26.86% 18.24% -5.52% -17.86% 6.02%
Telecom 6.23% 1.08% -20.79% -30.89% 10.07% 1.81% -18.75% 7.68%
Industrial 17.37% 7.46% -22.69% -36.04% 11.67% 15.25% -17.78% 20.68%
Technology 16.25% 56.44% -26.04% -52.09% 9.11% 19.38% -45.42% 33.17%
Materials -58.72% -43.68% -74.02% -65.67% 1.07% -52.45% -1.55% 98.10%
Energy 6.18% 2.03% -79.77% -67.28% 10.15% -8.08% -42.76% 41.17%
Cons. Disc. -53.87% -89.80% -361.68% -28.35% -17.94% -79.19% 104.61% 60.48%
S&P -10.95% -11.57% -33.83% -32.66% 3.21% -13.41% -11.77% 24.78%

Scorecard and Median EPS Growth Rates

  • Median EPS growth of 409 firms reporting so far is -7.8%
  • Those firms expect to see a 17.9% decline in first quarter
  • Yet-to-report firms expected to be down 11.1% in fourth quarter and 8.7% in the first quarter
  • The surprise ratio is 1.74 and the median surprise is 2.44%; both are below normal
  • Health Care still healthy with 12.1% growth, others flat or down
  • Health Care, Staples and Industrials doing well on surprise front
  • All sectors expected to be negative in 1Q

Positive surprises still outnumber disappointments, but at only about half the ratio that we became accustomed to seeing during the good times. CEOs learned long ago that it is better to under promise and over deliver, and thus keep the guidance to the analysts conservative.

The overall picture when we measure earnings based on median year-over-year EPS growth is not quite as bleak as on a total net income basis. During the first 3 quarters of 2008, firms were still buying back stock at a fairly aggressive pace (although not as aggressively as in 2007), which helps boost EPS by shrinking the denominator, where that effect is not present in the total net income data. Also the decline in total net income is in part been driven by some huge losses at some mega firms, most notably in the financial sector. The median EPS growth metric implicitly equally weights all of the firms.

Health Care is having the best quarter of any sector on just about every metric, with the highest total net income growth, the only positive median EPS growth, the best surprise ratio at 8.5:1 and a median surprise of 3.41. At this point it seems very unlikely that any other sector will come close to dethroning it as the earnings king of the quarter.

Among the stocks in the sector that reported very strong year over year gains in EPS as well as very large positive earnings surprises were some of the major drug firms like Bristol-Myers Squibb Co. (BMY - Free Report) , Merck & Co. (MRK - Free Report) and Schering-Plough Corporation (SGP). These firms have exactly the sorts of characteristics that you should be looking for in this sort of economic environment. Products that people will be very reluctant to stop buying, fortress balance sheets and good, well covered, dividend yields.

The disappointments have been concentrated among the Financials, where almost twice as many firms came in below expectations as above. The sector is responsible for 32.3% of all disappointments and just 10.8% of all positive surprises. There is very little in this sector that I find attractive, even at these apparently "bargain prices". In fact, over 30% of all companies currently expected to lose money for all of 2009 are in the financial sector, and most of those are banks.

Fourth-Quarter Scorecard (Reported)
Sector 4Q '08 (A) 1Q '09 (E) 2008 (A) 2009 (E) 2010 (E) %
Reported
Median %
Surprise
# Pos
Surprise
# Neg
Surprise
# Match
Healthcare 12.12% 5.13% 13.56% 5.17% 11.11% 88.68% 3.41% 34 4 9
Utilities 0.00% -2.35% 2.22% 1.74% 6.54% 70.00% 4.35% 12 6 3
Industrial -0.89% -21.54% 12.87% -12.05% 7.94% 98.15% 2.35% 32 10 11
Energy -2.89% -28.16% 20.30% -38.68% 13.05% 82.35% 0.68% 14 12 2
Cons. Stap. -5.10% -2.78% 8.33% 1.35% 8.93% 82.05% 3.57% 22 7 3
Tech -8.57% -30.21% 18.54% -17.45% 9.09% 95.83% 4.00% 41 20 8
Telecom -9.86% -11.11% 3.03% -10.65% 0.77% 55.56% 0.00% 2 2 1
Materials -24.18% -60.99% -4.62% -25.71% 15.19% 96.43% 5.21% 17 9 1
Cons. Disc. -30.87% -24.38% -5.80% -14.94% 9.92% 61.80% 3.77% 33 20 2
Financial -35.29% -40.25% -21.33% -4.87% 12.22% 78.26% -8.06% 25 43 4
S&P 500 -7.76% -17.92% 7.20% -6.37% 10.00% 81.80% 2.44% 232 133 44

Fourth-Quarter EPS Growth (Yet-to-Report)
Sector 4Q '08 (E) 1Q '09 (E) 2008 (A) 2009 (E) 2010 (E)
Telecom 9.48% -2.81% 13.59% 5.10% 23.23%
Industrial 7.23% 7.73% 10.21% 32.15% 3.06%
Cons. Stap. 6.82% 2.50% 15.27% 12.66% 4.89%
Financial 2.12% -2.88% 0.32% 5.76% 2.32%
Healthcare 0.00% 4.17% 14.88% 30.94% 15.96%
Utilities 0.00% 5.00% 0.00% 8.17% 8.97%
Energy -11.05% -33.33% 30.91% 33.68% 27.66%
Tech -21.84% -14.55% -16.98% 24.81% 19.80%
Cons. Disc. -31.71% -21.62% 25.37% 8.77% 18.81%
Materials -46.34% -36.80% 69.43% -10.17% 29.13%
S&P 500 -11.05% -8.71% 13.96% 12.21% 13.95%

The Zacks Revisions Ratio: 2009

  • Revisions ratio for full S&P 500 up to 0.22, from 0.20 last week
  • Health Care is the "strongest" as positive surprises help it
  • 8 sectors have at least 3 cuts for every increase; 7 have at least 5 cuts per increase
  • 34.2% of all firms see mean estimate decline by more than 10%, 8.8% will see a decline of more than 50%
  • The ratio of firms with rising to falling mean estimates is 0.17, down from 0.19
  • Total number of revisions (4-week total) up to 4,033 from 3,955 last week (2.0%)
  • Increases up to 736 from 667 (10.3%), cuts up to 3,297 from 3,288 (0.3%)
  • Estimate activity nearing seasonal peak

Despite 5 of the sectors recording at least twice as many positive surprises as disappointments, it is not translating into upward estimate revisions for 2009. Granted, unlike the other quarters, there is no automatic reason for 2009 estimates to rise due to a positive surprise in the fourth quarter of 2008, the way there is if there is a positive surprise in the first quarter of 2009. However, the disparity is pretty stark.

The Health Care sector is the best of the bunch, and it has almost moved into neutral territory. There, positive surprises are outnumbering disappointments more than 8:1. While the revisions ratio has improved from what we were seeing a month ago, it is still in horrendously negative territory and is happening on a far higher overall volume of estimate changes.

The size of the estimate cuts is awful, with more than one-third of all S&P 500 firms seeing their mean estimate fall by more than 10% over the last month and more almost a quarter seeing greater than a 20% decline. More than 1 out of every 11 S&P 500 stocks has seen its earnings expectations for 2009 cut in half in the last month. By contrast, less than 1% of all S&P 500 firms saw an increase of more than 10% in their mean estimates.

The economy is still accelerating to the downside, so it seems unlikely that the cutting will stop anytime soon. Not surprisingly the relatively defensive Health Care and Consumer Staples sectors are holding up better than the cyclical sectors like the Industrials and Materials. Financials they are in their own separate hell.

Sector Avg. 4wk EPS
Change (FY09)
Revisions
Ratio
Firms With FY09
EPS Increase
Firms With FY09
EPS Decrease
Health Care -1.68% 0.79 21 33
Technology -9.68% 0.34 12 58
Consumer Staple -3.63% 0.30 9 30
Consumer Disc -13.60% 0.19 10 68
Energy -18.89% 0.18 1 38
Utilities -5.48% 0.13 5 27
Telecom -5.67% 0.12 2 7
Industrials -11.04% 0.11 5 52
Materials -19.64% 0.11 1 27
Financial Services -14.20% 0.09 5 75
S&P 500 -10.71% 0.22 71 415

The Zacks Revisions Ratio: 2010

  • Sample size of 2010 revisions is thin, but starting off weak
  • Revisions ratio rises to 0.23 from 0.21 last week
  • Mean estimates to be affected by new estimates as much as revisions
  • More than 3 cuts per increase for 9 sectors, more than 5 per increase in 6 sectors
  • Health Care the "strongest"; Financials falling apart even for 2010
  • Excluding Health Care, revisions ratio at 0.18
  • Ratio of rising to falling mean estimates rises to 0.18 from 0.21
  • Total number of revisions rises to 1,850 from 1,778 (4.0%)
  • Estimate increases rise to 351 from 309 (13.6%), cuts rise to 1,499 from 1,469 (2.0%)

While the total net income table above shows expectations of a very healthy rebound in profits in 2010 of 23.2%, don't start counting those chickens. Analysts are cutting their 2010 estimates at almost the same pace that they are cutting their 2009 estimates. If the 2 fall in tandem, the growth rate will not change, but it will be off a much lower base.

As with 2009, the estimate cuts are widespread, with Health Care being the only place where cuts are running at less than 2:1 over increases, in every other sector they are running at more than 3:1. The size of the cuts is also very substantial. In 6 sectors, the average change in the mean estimate over the last month is in the double digits, and that is after we have removed all the declines of greater than 100%.

The Energy sector has seen many particularly large declines. One out of every three stocks in the sector has seen its earnings estimates for 2010 fall by over 20% in the last month. Then again, 1 out of every 10 Financials has seen their 2010 expectations more than cut in half over the last month.

Sector Avg. 4wk EPS
Change (FY10)
Revisions
Ratio
Firms With FY10
EPS Increase
Firms With FY10
EPS Decrease
Health Care -2.27% 0.66 15 38
Technology -12.15% 0.28 11 60
Materials -12.57% 0.27 5 23
Consumer Staples -3.17% 0.23 7 28
Consumer Discr -13.87% 0.20 9 64
Telecom -4.80% 0.19 2 7
Energy -14.24% 0.17 6 33
Utilities -3.95% 0.15 3 25
Industrials -10.24% 0.12 7 48
Financial Services -14.55% 0.10 5 74
S&P 500 -10.24% 0.23 70 400

Earnings Shares and P/Es

  • P/Es are too low since earnings estimates are too high
  • Earnings shares, including historical, based on current make up of S&P 500
  • Disappearance of losers like Merrill Lynch, Wachovia, and National City distorts Financials 2008 earnings share; with them it is under 4%.
  • Health Care expected to take earnings crown from Energy in 2009 and keep it in 2010
  • Energy earnings share expected to plunge to 13.8% from 21.4%
  • Financials 2010 earnings share expected to rise to 11.5% from 8.2% in 2008, but it was at 14.1% a month ago. It could possibly end up below 2008 levels.
  • Consumer Discretionary market-cap share far above earnings shares (overvalued?)
  • S&P 500's P/E of 12.4 equates to earnings yield of 8.06%, which is very attractive relative to 10 year T-note yield of 2.86%, but only mediocre relative to 6.12% A-rated 10-year corporate.
  • T-note rates are rising and more realistic earnings yields of near 6.00% based on lower earnings ($50) means the spread, while still attractive is not overwhelming.

Earnings Shares and P/Es
Sector 2008% 2009% 2010% Market
Cap %
P/E
2008
P/E
2009
P/E
2010
Health Care 14.81% 17.69% 15.75% 16.13% 11.6 11.3 10.2
Technology 15.13% 14.68% 14.22% 17.79% 12.5 15.0 12.5
Cons Stpl 11.83% 14.29% 12.27% 14.29% 12.8 12.4 11.6
Energy 21.36% 13.82% 14.77% 13.19% 6.6 11.8 8.9
Industrials 12.76% 12.19% 10.45% 10.10% 8.4 10.3 9.6
Financials 8.16% 11.45% 14.73% 9.28% 12.1 10.1 6.3
Utilities 4.17% 4.95% 4.38% 4.25% 10.8 10.7 9.7
Cons Discr 4.21% 4.71% 7.47% 8.41% 21.3 22.1 11.2
Telecom 3.97% 3.79% 3.22% 3.52% 9.4 11.5 10.9
Materials 3.59% 2.42% 2.74% 3.04% 9.0 15.6 11.1
S&P 500 100.00% 100.00% 100.00% 100.00% 10.6 12.4 10.0

Neil Malkin contributed significantly to this report.

Data in this report, unless stated otherwise, is through the close on Thursday 2/19/2009


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