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Dog Days of Summer

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Friday, August 9, 2013

Stocks appears on track to maintain the modestly negative tone of recent trading sessions, giving us the first negative week in almost two months. This is likely nothing more than summer time behavior, with investors taking profits ahead of an extended low-news, low-volume period.

The flow of economic data lately has generally been positive. The outlook for the U.S. economy was all along favorable, but recent data appears to be indicating improvement and stabilization in other markets as well. This morning’s better than expected Chinese industrial production data adds to other recent reports from that country, including this week’s trade numbers, indicating that the decelerating trend may have started to ease. Reports out of Europe appear encouraging as well, with the momentum in Germany particularly positive.

If this improving economic backdrop has to provide confirmation for the stock market’s strong year-to-date gains, then it needs to start showing up in positive revisions to earnings estimates. We haven’t seen that yet. In fact, estimate revisions activity has generally been to the down side for more than a year now and we are seeing that same trend at play in estimates for Q3 now, with estimates sharply down relative to where they stood just a few weeks back. This trend isn't in-sync with a market at these levels. 

Including this morning’s NRG Energy (
(NRG - Free Report) ) and Thursday evening’s Priceline () reports, we now have Q2 results from 452 S&P 500 members or 90.4% of the index’s total membership.  The Q2 earnings season has ended for 9 of the 16 Zacks sectors, including Finance, Utilities, Energy, Basic Materials, and Construction. A total of 13 S&P 500 companies report Q2 results next week, including Wal-Mart ((WMT - Free Report) ), Macy's ((M - Free Report) ), Nordstrom ((JWN - Free Report) ) and Deere ((DE - Free Report) ).

Total earnings for these 452 companies are up +2.9%, with 66.4% beating earnings expectations. On the revenue side, we have a growth rate of +2.2%, with 55.1% coming ahead of top-line expectations. This compares to total earnings growth rate of +2.6% on +1.9% higher revenues in Q1 for the same group of 452 companies. In terms of beat ratio, 66.6% of these 302 companies had come out with positive surprises in Q1, while only 43.8% had beat on top-lines in Q1. What this tells us that the growth rates and earnings beat ratio are broadly in-line with what we saw in Q1, while favorable top-line surprises are a bit more common.

This aggregate Q2 picture changes materially once the Finance sector is excluded. Total earnings growth turns negative (-3% excluding Finance vs. +2.9% including Finance) and even the beat ratios are far less numerous. This lack of breadth in the growth picture is troubling given loftier growth expectations from these sectors in the coming quarters. Given what we have seen outside of Finance in Q2, we will have to bring those expectations down to more realistic levels. That process has started already, but it still has plenty of room to go.

Sheraz Mian
Director of Research


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