With approximately 87% of the
S&P 500 companies having reported 4th quarter 2012 earnings, it
has become clear that the 4th quarter will be the second consecutive
quarter in which operating earnings are lower than in the same quarter of the
prior year. While much has been made about the fact that the vast majority of
companies have beaten estimates, investors would do well to remember than a
little more than a year ago, bottom up consensus estimates called for earnings
growth in excess of 19%. True, 4th quarter operating earnings were
hindered by a number of companies changing their pension accounting
methodology, but the fact remains that over the last 12 months, expectations
for 4Q12 earnings declined rather dramatically and most of the decline occurred
well in advance of company decisions to alter pension accounting. In that
light, this earnings season is a rather significant disappointment. With the
vast majority of companies having reported, it is also clear that operating
earnings growth for 2012 will be less than 1%. As our chart indicates, S&P
500 operating earnings over the last four quarters is actually about 1.75% lower
than it was over the four quarters ending last June. That is far from a
disaster, especially given the speed at which earnings grew from mid-2009
through mid-2011. However, it is clear that earnings growth has been
decelerating significantly over the last six quarters.
While consensus bottom up
operating earnings estimates for 2013 have declined significantly since the
start of the year, we continue to believe that they remain far too optimistic. Not
surprisingly, estimates have fallen most for the 1st quarter with
smaller declines for each of the subsequent two quarters. Consensus for the 4th
quarter has actually risen modestly. That is not surprising given analysts’
proclivity for optimism and the fact that over the last six quarters analysts
final consensus estimates for quarterly earnings have consistently fallen
significantly from their initial levels. In short, analysts have consistently
and significantly overestimated earnings power, forcing them to reduce their
estimates over subsequent, quarters. Ultimately, they have reduced them
slightly too far and as a result, the majority of S&P 500 companies have
beaten final estimates over the last six quarters. Another result is that
investors and market pundits, suffering from short-memories, describe the
earnings season as strong because the majority of companies beat final
estimates.
Currently, bottom up consensus
for 2013 S&P 500 operating earnings are for $111.28/share, or an increase
of approximately 14.5% over 2012 operating earnings. Even taking into account the
impact of accounting changes on 4Q12 earnings, this expectation is ridiculously
optimistic, as is the 2014 consensus of $125.71/share, which 13% above the 2013
consensus. Essentially analysts seem to think we are in a lull that is bound to
get better, but that rationale holds little support. Consensus estimates of earnings growth for
2013 and 2014 are above the median level of just about 12% over 93 rolling
annual earnings periods (rolling by quarter) dating back to 1989. Government
deficits contribute to earnings and that fiscal policy is tightening. The end
of the payroll tax holiday will cut disposable income for the median household
by approximately $1,000 this year and the top income tax bracket and top
capital gain bracket has been raised. Sequestration, which is set to take place
on March 1, may yet be averted, but if so, it seems likely that there will
still be some additional spending cuts. In short, fiscal policy is tightening
and the immediate impact is negative for corporate earnings growth, which has
weakened significantly over the last six quarters. Additionally, global growth
remains weak and US companies have little fat left to cut. Given these facts,
consensus bottom up earnings forecasts for 2013 and 2014 seem almost risible.