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Looking For Validation

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Monday, January 6, 2014

Stocks started off the New Year hung over from last year’s festivities, but ‘normal’ trading activities only get underway today as folks get back to work from the holidays. Hard to imagine, however, how things can get back to ‘normal’ with the deep freeze across the Midwest and much of the country today.

The chilly weather notwithstanding, the growth outlook for the U.S. economy has certainly perked up lately, with many across Wall Street looking for data to validate the Fed’s Taper decision. Last week’s manufacturing ISM data was along those lines and we will likely get further support to that thesis from today’s service sector ISM reading as well. The global PMIs were a mixed bunch, with the picture particularly underwhelming in the emerging markets. In China, both the private sector and government PMI readings showed a loss of momentum from the preceding month. The key report now is the year’s first U.S. jobs reading coming out Friday, which is expected to show gains close to the recent monthly run rate.  

The market’s strong gains also need to be validated by corporate earnings fundamentals. We will get another look at the earnings picture with the 2013 Q4 earnings season about get into the spotlight. The earnings picture certainly isn’t bad, with quarterly earnings totals in record territory over the last couple of quarters. But it isn’t consistent with a market sitting pretty in record territory either. We haven’t had much growth lately and estimates have consistently been coming down as companies have guided lower.

The same has happened with Q4, with current expectations of +6.3% total earnings growth for the S&P 500 down sharply from what was expected at the start of the quarter. While actual growth will most likely be higher than what is expected at present, a function of the corporate world’s expectations management game, even the lowered +6.3% growth pace will be the highest of 2013. But a big contributor to the perked up Q4 growth rate is easy comparisons – 2012 Q4 was lowest quarterly total in the last two years.

Comparisons are particularly easy for the Finance sector, with Bank of America (BAC - Free Report) enjoying a roughly $2 billion swing from the year-earlier level. The Insurance industry had to deal with unusually tough conditions in the wake of the Sandy disaster and its growth picture also looks a lot better in comparison. Total Q4 earnings growth for the S&P 500 drops to almost half once is Finance is excluded. Others like Verizon (VZ - Free Report) also have easy comps.

Not to belabor the easy-comps issue too much, but the point is that Q4's stronger-looking growth pace is no evidence of a growth acceleration. Consensus expectations are for a strong growth ramp this year and beyond, with total earnings for the S&P 500 expected to be up in double-digits. The question is will the markets continue the upward trajectory this year, even at a slower pace as many seem to be looking forward to, if those earnings expectations start coming down.

We will have to wait and see.

Sheraz Mian
Director of Research

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