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: Fourth quarter earnings season has started and expectations have been dialed back significantly. S&P Capital IQ now expects growth in Q4 to be only 3.3 percent as compared to the previous 16.5 percent. What are some of the main reasons for that reduction?
Stovall: Well, anytime you talk about fourth quarter estimates at the beginning of the year, it should be taken with a grain of salt because as the year progresses, a backend-loaded year typically sees the earnings estimate trend exactly as we did this year. Also, another reason why the earnings expectations are now at the low single digits rather than the mid teens is because of the impact of Hurricane Sandy, not only on the economy but also on productivity in the New York area. Also, there was the Fiscal Cliff. Consumers as well as businesses pretty much sat on their hands waiting on Congress to come to some sort of decision that would affect their tax policies and nobody really wanted to engage in any kind of longer-term investment plan if they had no clue on how they would be taxed. So the belief is that fourth quarter GDP will probably be a little weaker than anticipated as well, but at least fourth quarter 2012 earnings growth is expected to be both positive and higher than what we saw in Q3.
EQ: What are some implications or signs that investors should take note of to get a better idea for what to expect in 2013?
Stovall: I think right now the expectation is still for a muted “V” shaped recovery in operating earnings growth. The weakest quarter occurred in the second quarter with a gain of less than 1 percent, followed by 2.5 percent in the third quarter, and now the expected 3.3 percent in gains for the fourth quarter. Gains in 2013 are expected to rise sequentially through the year with the fourth quarter being the greatest at more than 17.5 percent. Again, it looks as if 2013 will look fairly similar to 2012, but we’ll have to see if that comes true.
EQ: Which sector is expected to be the strongest/weakest?
Stovall: Our expectation right now is for seven of the 10 sectors in the S&P 500 to post year-over-year advances. The three likely to see the biggest gains are Consumer Discretionary, Financials, and Telecom Services. The three weakest areas are expected to be Healthcare, Industrials, and Information Technology. The strongest groups are likely to see increases in the low-teens in earnings, while the laggards are expected to see low single-digit declines in year-over-year earnings. For almost every sector, the headwinds in earnings are expected to be related to Hurricane Sandy and the Fiscal Cliff. In addition to that, there’s also about a 2-percent increase in the value of the U.S. dollar in the fourth quarter 2012 versus fourth quarter of 2011. One of the tailwinds, however, is expected to be a near 8-percent decline in the cost of oil. That should benefit most industries because almost all are users of energy.
EQ: Q4 results have the highest standard deviation of the four quarters in a fiscal year. What does that mean and what are some of the reasons for that?
Stovall: I looked at operating earnings back to 1988, which is as far back as people on Wall Street looked at operating results, and I at GAAP (as reported) earnings back to 1936, and I came up with an average year-over-year percent change for each of the four quarters. What was consistent was that the weakest quarterly growth was seen in the fourth quarter on average, whether you’re look at operating results or looking at GAAP results. The strongest advances were typically seen in the first quarter.
In terms of standard deviations—how much actual numbers vary during that quarter or in other words, what kind of a wiggle effect they experience—in both cases, the fourth quarter shows the widest disparity of average returns. I think a lot of that has to do with what’s called a budget flush, which means that if you don’t use unused capital allotted in your budget this year, then you will end up losing it the next. Believe it or not, we did not see much of a budget flush or expect to see it for Information Technology in 2012. Also, in those years where companies had very bad earnings, such as 2008, companies end up throwing out the kitchen sink, as they call it, using the final quarter of a bad year to write down everything they can think of to make that year’s results look so bad that the subsequent year’s will look that much better.
EQ: Last week, minutes from the December FOMC meeting suggested that the Federal Reserve may not be as dovish as most investors expected. Could we actually see rates rise in a meaningful way sometime this year?
Stovall: It depends on what you mean by a meaningful way. Our belief is that we could see the yield on the 10-year note go up between 2.1 to 2.2 percent, but not dramatically higher than that. This is mainly because the economy remains in a fairly fragile state. Our expectation is that in this fourth year of an economic recovery, rather than getting the more normal 4 percent growth that we saw dating back to World War II, we’re likely to see a 2.3 percent growth rate for June 2012 through June 2013. So the recovery is still a low-flying one, but we think it’s gaining altitude but not enough to push up the yield on the 10-year note dramatically.
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