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: In this week’s Sector Watch report, you recapped the first quarter earnings season for the S&P 500. While actual results beating expectations is somewhat normal, just how well did the 500 do against estimates?
Stovall: True earnings came out about 4.5 percent better than expectations, which was in line with the average range of actual results beating estimates. The normal range is between 4 to 5 percentage points. At the beginning of the quarter, S&P Capital IQ reported that Wall Street consensus estimates was calling for a 0.5 percent increase in first quarter year-over-year operating earnings. However, when all was said and done, we rose 5.2 percent. So that certainly was encouraging for those investors who think that the economy and corporate earnings continue to move higher.
EQ: The glaring concern remains the ability to generate meaningful revenue growth. Have there been any encouraging signs that corporate management is shifting emphasis from the bottom line to the top line?
Stovall: The revenue picture does look pretty bleak. First, it was estimated that we would see 4-percent revenue growth, but in the end, we only got a 0.5 percent gain in top line growth. That number is similar to what the estimate is for the second quarter. If there is anything encouraging out there to suggest that top-line growth could improve is that expectations for global GDP are likely to improve in the second half.
According to S&P Capital IQ, as well as IHS Global Insight, the 2.7 percent and 3.0 percent growth in Q3 and Q4 Global GDP, respectively, is expected to come from a slight recovery in the depressed developed nations around the globe, while frontier and emerging markets should record no change from their 3.3 percent and 5.3 percent growth expectations. Also, the gradual reduction in U.S. unemployment is a possible sign of companies slowly willing to increase their payrolls. They would only be doing that if the demand for their products and services are expanding to the point where it could not be handled by increased overtime efforts of existing employees.
Lastly, I would say that the slow pickup in mergers and acquisition activity also signals that those acquiring companies believe that there is enough of future growth to warrant their need to expand and to get into new markets.
EQ: Financials is expected to be arguably the strongest performer for the second quarter. What are some notable drivers for that sector?
Stovall: Financial is expected to show a 15.9-percent increase for second quarter earnings, which is on top of the 11-percent increase we saw in the first quarter. It’s also fairly consistent with what we’re expecting for the full year. Financials is expected to see a gain of 11.1 percent, and tie for third place among the 10 sectors of the S&P 500.
Revenues are also supposed to look pretty good, up 7 percent as compared with the 0.5-percent for the S&P 500. I think the reasons for this are that, first, the banks are expected to show a pretty healthy EPS gain—possibly as much as 20 percent by our view—aided by an improvement in loan growth, as well as a reduction in loan loss provisions. Also, Financials should be doing well going forward because of the stronger-than-average earnings growth, attractive valuations, and the steepening yield curve, which should help net interest margins.
EQ: The Technology sector is expected to have its worst quarter of 2013 in Q2, leading the laggards for the S&P 500. It does, however, pick up in the second half. What’s the cause for this expected upcoming weakness and rebound?
Stovall: We believe that it reflects the absence of new products, which will result in the projected weakening of year-over-year earnings growth. This is particularly true for some of the largest companies on the index. Also, we see broader headwinds, more global in nature, due to a lot of challenges in the areas related to computers. There are worries about the continued weakening of global economies in the second quarter, as well as the impact of the sequester here in the U.S., which would lead to the reduction in computer demand and spending from the federal government.
So while we think that there could be some good secular growth relating to mobile and cloud computing, these trends actually have negatively affected demand and pricing for some of the more traditional technology offerings. So in one sense, the right hand is taking a lot from the left hand.