Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: We’re a little past the halfway point for Q1 earnings season, and so far about 70 percent of the companies that have reported so far have beat estimates. At this current pace, it looks like Q1 2013 will avoid becoming the troughing quarter that some were concerned about heading into this reporting season. Is this an encouraging sign for bulls?
Stovall: It is encouraging, certainly from an earnings perspective, because at the beginning of the first-quarter reporting period, S&P Capital IQ reported that consensus estimates expected only a 0.5-percent increase, but now earnings are actually expected to be up by over 4 percent this quarter as data continues to be revised. So I would tend to say that gives the bulls additional reasons to feel that this economy’s trajectory continues to increase slightly despite the less-than-stellar economic reports that have been coming out since the beginning of April.
EQ: Revenue growth continues to be a concern despite the strength in earnings. There’s a risk that we could actually end up with a decline in year-over-year revenues. Should investors be more concerned about this trend?
Stovall: Revenues are a very important part of the overall earnings equation. Companies can certainly cut costs to improve earnings. They can even engage in a little bit of accounting sleight-of-hand through share repurchases, and therefore increase the earnings per share. However, in the end, you need to see top-line growth improve in order to justify an increase in the overall economy. Right now, we’re just not seeing that.
At the beginning of this earnings period, S&P Capital IQ reported that we would probably see a 4-percent increase in revenues, but now the increase is expected to be about 1.5 percent. What’s also interesting is that there was a larger percentage of companies that missed materially (2 percent or more) than those that had exceeded estimates of the same range. So when we do exceed, we are doing it more to the downside than we are to the upside. I would tend to say that for us to maintain a relatively bullish stance toward the economy and corporate earnings we need to see an improvement in the revenue picture in the quarters ahead.
EQ: You stated in this week’s Sector Watch that the true catalyst for the strength of equities prices is most likely the fact that investors lack a better alternative. Considering that the inflow into bonds versus stocks is still somewhat balanced, what kind of potential do you see for stocks if the Great Rotation is actually triggered?
Stovall: If the Great Rotation is actually triggered, I think there’s a tremendous opportunity. Historically, whenever the yield on the S&P 500 has exceeded that of the yield of the 10-year Treasury, the average 12-month price performance for the S&P 500 has been a gain of 19 percent. We all know history is a guide and not gospel, but still, I think it implies that those people who have an awful lot of money in bonds and probably would want to lighten up should they get a couple of quarters of negative bond portfolio statements. They would then decide to put their money somewhere else that can earn a return, which would be equities.
Should that Great Rotation occur, I would tend to say that would be a tremendous afterburner to the propulsion of equity share prices.
EQ: Is the appeal in bonds still the fact that people are willing to pay for safety?
Stovall: The appeal is for a return that is greater than cash or CD accounts, and there is a bit of safety. Let’s remember that in 2008, while the S&P 500 fell 37 percent on a total return basis, the MSCI EAFE fell 43 percent, and the Emerging Markets fell 53 percent, Barclays Long-Term Treasury Bonds gained 24 percent, and the Barclays Aggregate was up 5.6 percent. So in that kind of environment, investors remember that should we end up experiencing some sort of digestion of gains, decline in price, or whatever you want to call it, in equities, you will probably see a rotation back into the bond side once again.
EQ: Looking at first quarter GDP growth, there were some mixed messages from the strength of the private sector and a drag from the public sector. Is this an indication of the possible longer-term impacts of the sequestration cuts on the economy?
Stovall: The sequestration cuts basically have been throwing the government into disarray because they’re just slicing off the top and are not strategically pruning areas that are bloated within the overall government. However, our economists believe that the Q1 report was much more encouraging than was seen at first blush. Because we saw underlying private sector strength, that was an indication that the private sector was able to absorb a lot of the fiscal shocks. Consumer spending rose at the fastest pace in two years and businesses kept investing after they had opened their pocketbooks in the fourth quarter, so that was more likely to be taken as a positive rather than a negative. Should we get some sort of a compromise to come out of Washington, like the Great Rotation, that could be a very positive catalyst toward further advancing equities.
EQ: If the sequestration cuts aren’t resolved or are left in place, could this disarray end up having lasting impacts on the private sector’s growth?
Stovall: It depends on how many “ifs” are asked as it relates to government dysfunction. The more you ask, the dourer the overall picture looks. I would tend to say the longer this dysfunction goes, the deeper it probably does dig into consumer spending and confidence patterns, and the greater negative impact it will have in the long run.
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