Earnings season mid way point - time to check in!

by Wayne Ferbert on October 28th, 2013

We are just about half way through earnings season announcements for Q3 2013. The actual EPS results are on track to set a record for this quarter and the trailing 4 quarters according to Goldman Sachs (see Business Insider article here).
 
The main points of the analysis from Goldman Sachs analyst Amanda Sneider: (1) Q3 earnings bump driven by Financials and margin expansion; (2) revenues and margins have been in line with expectations; and, (3) an above average number of firms have been guiding down Q4 expectations.
 
So far, the market has cheered the continuing QE program and solid to even ‘robust’ EPS results. The S&P is sitting at all time highs right now today!
 
But some of this analysis is worrisome to me. Back in September on this blog post, we pointed out how Financials were really disproportionately driving Earnings growth in the S&P 500. In fact in the last year, if you took financials earnings growth out, there would be very little S&P 500 EPS growth.
 
So, the fact that Financials are still the straw that stirs the EPS drink? That doesn’t seem like an economy that is producing more widgets – just paying more to account for them.
 
In addition, the EPS growth being driven by margin expansion is good – but not the sign of a growing economy. Companies prefer to grow their EPS thru revenue growth – not because they cut costs or found new pricing power.
 
The last troubling observation: the fact that the Q4 downgrades have been more common than usual. Again, this is not a sign of an expanding economy. However, I won’t worry too much about this one yet as we all know these firms love to sandbag on earnings going forward.
 
In the end, I can’t help but come to the following conclusion: would you really want to pay $1650+ for the S&P500 if the underlying economy was still mediocre at best? Isn’t it a mediocre economy if only one sector seems to be growing and EPS gains only come from cost cutting?
 
Also, what are the real earnings of these firms if interest rates were more normalized? How much of the earnings is QE dependent?
 
Don’t get me wrong: I think our government can keep QE going for a long time in to the future – and we want to ride the resulting strength in the S&P 500 for as long as possible. But when it ends, do you think it will be a soft landing? Because any portfolio that lacks the appropriate hedges is basically betting on the Federal Government’s ability to produce a soft landing.

Given our government’s track record, I am skeptical.


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