Just 24 firms, or less than 5% have reported second-quarter earnings, so far, but the results are somewhat encouraging. Positive surprises are leading disappointments by a 3.2:1 ratio, inline with recent historical norms. The median surprise is also inline with recent history at 3.66%. Expect both the surprise ratio and the median surprise to jump around quite a bit in the early going of the earnings season.
The median year-over-year EPS growth rate of 10.84% would be wonderful news for the market, if it can be held on to as the season progresses. However, on close examination of the expectations for the second quarter, that seems unlikely, but possible. The median expected EPS growth rate for the 95%+ of firms that are yet to report is only 6.85%. This would imply that the median surprise would have to be almost 4.0% for the quarter. It could happen, but the odds are against it.
Energy is currently expected to win the growth derby, not exactly a shocking idea with oil currently hovering in the $135 a barrel area. Perhaps the bigger question is: Why isn't the expected growth rate much higher than it is? After all, the price of crude has just about doubled since this time last year. Since it costs them something to get the oil out of the ground last year one would expect that gross profits would more than double as a result. The 22.3% year over year growth in EPS for the sector looks very conservative to me (but up from 21.6% last week, and 19.7% two weeks ago).
Tech and Health Care are currently expected to win Silver and Bronze in the second quarter, with growth of 15.8% and 12.4%, respectively.
Once again, the biggest expected loser in the quarter is expected to be the Financials, with half the firms seeing a drop in their EPS of over 11.0%. Consumer Durables follows closely behind with an expected drop of 8.9%.
Given that the bulk of the stimulus checks are being mailed out in May and June, it would not surprise me if the retailers in the sector do a little bit better than expected for the quarter. However, even if that is the case, the effect would be short lived. The expected rebound to 4.7% growth in the third quarter seems to reflect slower assumptions about the pace of stimulus check disbursements than has actually happened.
Some of the factors which should help median EPS growth are share repurchases, which even though they have slowed in recent months, will still reflect what happened last year. Oddly, increased share counts will also help boost EPS among the Financials. Since the companies that have increased their share counts the most (by going hat in had to the sovereign wealth funds looking for new capital) are the ones that are likely to reports losses, so the loss per share will be less.
In addition to the extent that firms have large operations overseas, they should benefit from the currency translation effects of the weak dollar. The weak dollar has also boosted those companies that export a substantial portion of their sales.
| Second-Quarter Scorecard (Reported) |
| Sector | Q2 08 Median
Growth Rep. | Q3 08 Median
Proj. Growth. | 2007 Median
Rep. Growth | 2008 Median
Proj. Growth | % Reported | Median %
Surprise | # Pos
Surprise | # Neg
Surprise | # Match |
| Materials | 42.16% | -27.78% | 57.48% | 70.62% | 3.57% | 7.41% | 1 | 0 | 0 |
| Tech | 25.00% | 10.65% | 10.64% | 19.22% | 8.45% | 4.77% | 5 | 0 | 1 |
| Cons. Stap. | 12.82% | 8.79% | 11.05% | 10.94% | 12.20% | 0.00% | 2 | 1 | 2 |
| Cons. Disc. | 10.26% | 3.64% | 7.51% | 6.03% | 8.14% | 4.00% | 6 | 1 | 0 |
| Industrial | -26.02% | -41.77% | -13.37% | -15.50% | 1.82% | -1.36% | 0 | 1 | 0 |
| Financial | -39.06% | -31.21% | -7.35% | -23.94% | 4.44% | -3.08% | 2 | 2 | 0 |
| S&P 500 | 10.84% | 4.45% | 10.64% | 10.02% | 4.80% | 3.66% | 16 | 5 | 3 |
| Second-Quarter Yet-to-Report |
| Sector | Q2 08
Proj. Growth | Q3 08
Proj. Growth | 2007
Rep. Growth | 2008
Proj. Growth |
| Energy | 22.32% | 34.12% | 12.83% | 23.31% |
| Tech | 15.79% | 15.50% | 16.98% | 14.77% |
| Healthcare | 12.37% | 12.97% | 16.72% | 13.15% |
| Industrial | 10.85% | 12.05% | 16.57% | 13.54% |
| Telecom | 10.00% | 4.00% | -2.94% | 8.16% |
| Cons. Stap. | 8.16% | 11.11% | 12.56% | 9.55% |
| Materials | 2.61% | 10.00% | 10.85% | 7.67% |
| Utilities | 1.75% | 5.00% | 9.09% | 6.06% |
| Cons. Disc. | -8.87% | 4.67% | 7.45% | 1.98% |
| Financial | -10.99% | -5.59% | 2.14% | -0.52% |
| S&P 500 | 6.85% | 8.76% | 12.00% | 9.94% |
Total Net Income Growth
Total net income for the S&P 500 is expected to fall for the third straight quarter. However, the magnitude of the decline is expected to be less than we saw in either the first quarter or in last years' fourth quarter.
The blame for net income decline once again goes to the Financials (with best supporting actor nomination for the Consumer Discretionary), but so does the credit for a less severe decline than last quarter.
Overall, total net income for the S&P 500 is expected to be 12.2% below the second quarter of 2007. In the Financial sector, total net income is expected to be 51.9% lower (was 48.7% last week). In both cases, this marks a significant improvement over the first quarter when the overall S&P 500 was down by 16.2% and the Financials were down 79.3%.
Things are also falling apart for the Discretionary firms, even despite the massive forced lending program known as the stimulus checks. Total net income for the sector is expected to be down 29.2% from a year ago, and even worse showing than the 20.3% year-over-year decline posted in the first quarter.
Looking at the very early reports in so far (very small sample, so these are just very early indications) things look very bleak indeed for the Financials with the total net income of the four firms that have actually reported so far down 89% from a year ago. Those four firms reported a total of $705 million in profits this year versus $6.4 billion last year. There will be more massive write-offs this quarter, but hopefully not quite as massive as we have seen in the previous two quarters. The key flavor of the quarter this time around should be write-offs related to counterparty risk with the monocline insurance firms like Ambac (ABK) and MBIA (MBI) which have finally lost their AAA designations.
Total net income for all the S&P 500 firms that have reported so far is 40.9% below last year.
Energy is expected to be the only sector to post a double-digit gain in total net income for the quarter, with a rise of 15.8% (was 14.4% last week), but even there, that is significantly slower growth than the 25.8% posted in the first quarter. With oil at $135 or so, and natural Gas over $13, the 15.8% rise in total net income for the sector is seems very conservative, and points to the amount of escalation on the cost side of the equation for the Energy firms. Yes, the price of oil is going up, but so too is the price of the steel pipe they put in the ground when they drill a well. While overall, there is a significant tendency for analysts to be too conservative in their earnings estimates, I suspect that Energy will be the place with the most potential for large positive surprises.
Tech and Staples are expected to take Silver and Bronze with growth of 9.5% and 6.9%, respectively.
Overall, it is a picture of widespread earnings weakness for the quarter. The biggest question is the extent to which the Financials have already come out with all their dirty laundry over the last two quarters. I suspect there is more out there than is reflected in the current expectations, and the total net income decline for the Financials might be larger than the 51.9% now anticipated, although still less than the 79.3% decline in the first quarter.
| Total Net Income Growth (Reported) |
| Sector | Q4 07
Rep. Growth | Q1 08
Rep. Growth | Q2 08
Rep. Growth | Q3 08
Proj. Growth | 2007
Rep. Growth | 2008
Proj. Growth | 2009
Proj. Growth |
| Materials | 184.44% | 84.24% | 43.54% | 20.12% | 57.71% | 70.38% | 26.06% |
| Technology | 8.16% | 9.91% | 24.08% | 22.63% | 31.84% | 11.02% | 28.24% |
| Cons. Stap. | 9.25% | 15.65% | 9.61% | 4.68% | 20.90% | 5.09% | 12.10% |
| Cons. Disc. | 21.37% | -8.25% | -4.07% | 0.24% | -8.30% | 16.25% | 14.64% |
| Industrials | -18.64% | -6.43% | -25.41% | -41.68% | -0.98% | -16.66% | 25.30% |
| Financials | -89.19% | -47.13% | -88.99% | -44.15% | 3.06% | -44.41% | 49.36% |
| Materials | 20.12% | 43.54% | 84.24% | 184.44% | 26.06% | 70.38% | 57.71% |
| Total Reported ($) |
| Sector | Q2 08
Rep. Growth | Q2 07
Rep. Growth | Q1 08
Rep. Growth | Q1 07
Rep. Growth |
| Materials | $811 | $565 | $1,000 | $543 |
| Industrials | $455 | $610 | $393 | $420 |
| Cons. Disc. | $1,286 | $1,340 | $1,744 | $1,901 |
| Cons. Stap. | $1,387 | $1,265 | $1,687 | $1,459 |
| Financials | $705 | $6,397 | $3,773 | $7,136 |
| Technology | $2,619 | $2,111 | $1,765 | $1,605 |
| S&P | $7,262 | $12,289 | $10,362 | $13,064 |
| Total Earnings Growth: Yet-to-Report |
| Sector | Q4 07
Rep. Growth | Q1 08
Rep. Growth | Q2 08
Proj. Growth | Q3 08
Proj. Growth | 2007
Rep. Growth | 2008
Proj. Growth | 2009
Proj. Growth |
| Energy | 23.14% | 25.77% | 15.77% | 38.74% | 5.92% | 31.53% | 10.42% |
| Technology | 31.46% | 13.42% | 8.05% | 8.40% | 11.66% | 20.28% | 16.98% |
| Cons. Stap. | 6.26% | 11.10% | 6.72% | 8.21% | 7.39% | 2.50% | 10.63% |
| Health Care | 17.26% | 3.21% | 3.09% | 3.60% | 18.43% | 8.62% | 11.20% |
| Industrial | 6.73% | 5.79% | 1.61% | 4.80% | 10.25% | 9.13% | 13.03% |
| Utilities | 13.21% | 8.90% | -1.77% | 3.29% | 10.36% | 7.02% | 10.84% |
| Telecom | 31.66% | 1.41% | -2.46% | -5.10% | 17.74% | 1.54% | 10.29% |
| Materials | -6.70% | 8.11% | -6.29% | 7.89% | 5.59% | 9.09% | 13.69% |
| Cons. Disc. | -0.57% | -21.73% | -31.21% | -4.32% | -5.88% | 0.00% | 31.36% |
| Financials | -123.32% | -83.76% | -47.60% | 1.61% | -24.08% | -25.83% | 54.09% |
| S&P | -20.15% | -15.92% | -10.52% | 9.25% | -0.04% | 5.18% | 19.50% |
| Total Earnings Growth: Combined |
| Sector | Q4 07
Rep. Growth | Q1 08
Rep. Growth | Q2 08
Proj. Growth | Q3 08
Proj. Growth | 2007
Rep. Growth | 2008
Proj. Growth | 2009
Proj. Growth |
| Energy | 23.14% | 25.77% | 15.77% | 38.74% | 5.92% | 31.53% | 10.42% |
| Technology | 29.78% | 13.17% | 9.51% | 9.21% | 13.15% | 19.48% | 17.88% |
| Cons. Stap. | 6.48% | 11.45% | 6.91% | 7.98% | 8.20% | 2.67% | 10.73% |
| Health Care | 17.26% | 3.21% | 3.09% | 3.60% | 18.43% | 8.62% | 11.20% |
| Industrial | 6.07% | 5.53% | 0.89% | 3.79% | 9.98% | 8.57% | 13.23% |
| Utilities | 13.21% | 8.90% | -1.77% | 3.29% | 10.36% | 7.02% | 10.84% |
| Telecom | 31.66% | 1.41% | -2.46% | -5.10% | 17.74% | 1.54% | 10.29% |
| Materials | -3.71% | 14.25% | -2.73% | 7.70% | 7.09% | 11.68% | 14.49% |
| Cons. Disc. | 0.97% | -20.25% | -29.16% | -3.69% | -6.13% | 1.59% | 29.49% |
| Financials | -119.24% | -79.31% | -51.91% | -4.63% | -21.60% | -28.06% | 53.65% |
| S&P | -21.67% | -16.22% | -12.18% | 7.64% | 0.39% | 4.03% | 19.95% |
The Zacks Revisions Ratio
To help gauge the direction of the market, we take note of what analysts are thinking. By tallying their EPS changes, we can determine our revisions ratio. This ratio simply divides the total number of positive estimate revisions by the total number of estimate cuts. Thus, a high ratio is a bullish indicator and a low ratio is bearish. For the S&P 500 as a whole, a number below 0.80 or above 1.25 is generally significant. For individual sectors the distance from 1.0 should be greater for the numbers to be significant.
The revisions ratio for 2008 fell back again, after a slight blip up last week. It has now fallen in four of the last five weeks. It is now at 0.84, a reading that we generally consider a weak neutral, down from 0.91 last week.
The overall pace of estimate revisions is past the peak for this quarter, and is starting its seasonal rise. During the last four weeks there have been 1,289 changes in estimates: 590 up and 699 down, up 11.2% from 1,159: 572 up and 587 down last week. The total number of revisions will most likely triple from current levels over the next five or six weeks. The ratio of firms with rising mean estimates to falling mean estimates is 0.92, slightly stronger than the revisions ratio, and in neutral territory. Three sectors are in positive territory, one in neutral and six in negative territory.
Energy was far and away the strongest with over five increases for every cut. While estimate increases were widespread in the sector, firms worth highlighting would include Noble Energy (NBL), Occidental Petroleum (OXY) and Southwestern Energy (SWN). From a total economic impact point of view, significant increases were also seen for all of the big three, Exxon (XOM), Chevron (CVX) and Conoco (COP).
Tech followed with over three increases for each cut. Dell Computer (DELL) was the most significant contributor to the Tech strength, although chip stocks were generally strong as well. The Financials were once again in the cellar, with almost three cuts per increase, although the pace of estimate cuts is less than we have generally seen in recent months. Regional Banks like Keycorp (KEY) and Zion (ZION) were among the weakest of the Financials. Lehman Brothers (LEH) and Morgan Stanley (MS) were also beaten down by the analysts.
| Avg. 4wk EPSChange (FY08) | Avg. 4wk EPS
Change (FY08) | Revisions
Ratio | Firms With FY08
EPS Increase | Firms With FY08
EPS Decrease |
| Energy | 2.52% | 5.23 | 30 | 7 |
| Technology | 0.10% | 3.21 | 39 | 23 |
| Consumer Staple | -0.89% | 1.26 | 14 | 25 |
| Utilities | -0.06% | 1.10 | 11 | 11 |
| Health Care | -0.18% | 0.53 | 26 | 21 |
| Consumer Disc | -3.43% | 0.52 | 27 | 50 |
| Telecom | 3.04% | 0.52 | 3 | 6 |
| Materials | -0.10% | 0.50 | 9 | 13 |
| Industrials | -0.63% | 0.47 | 26 | 21 |
| Financial Services | -149.08% | 0.34 | 28 | 54 |
| S&P 500 | -26.85% | 0.84 | 213 | 231 |
The 2009 revisions story is similar to the 2008 story, just slightly weaker. The revisions ratio also resumed its decline after it bounced up slightly last week. It fell to, 0.82, up from 0.89 last week, and exactly where it was two weeks ago. We still consider that to be in neutral territory. Virtually all the strength is in the Energy sector, with a revisions ratio of 5.03. Tech also put in a decent showing at 3.21, or five increases for every two cuts. The Energy sector accounted for over one quarter off all estimate increases over the last four weeks, and less than five percent of the estimate cuts. Twelve of the 37 firms in the Energy sector have seen their 2009 earnings estimate increase by double digits over the last four weeks alone, including all of the big three (XOM, CVX and COP).
In Tech, the PC manufacturers, DELL and Apple (AAPL) were particularly strong.
The revisions picture for the Financial sector is even worse for 2009 than it is for 2008, coming in at 0.25, or four cuts for every increase. Revisions like these will eat away at the robust earnings rebound seen for 2009 (unless 2008 gets cut faster). We do not seem to be getting out of the woods on the Financial sector front. While there is weakness throughout the sector, one of the worst areas seems to be Banks with big exposure to Ohio, such as Keycorp (KEY), Fifth Third (FITB), Huntington (HBAN) and U.S. Bankcorp (USB).
The total number of revisions for the whole S&P 500 for 2009 is also well past its seasonal peak, and starting up out of the valley. There were a total of 1,162 revisions: 524 up and 638 down. This is up 11.9% from 1,038 (490 up and 548 down) last week. As second quarter earnings start rolling in, expect the pace of revisions activity to pick up significantly. The ratio of firms with rising mean estimates to falling mean estimates is 0.84, in line with the revisions ratio, and also a weak neutral.
| Avg. 4wk EPSChange (FY09) | Avg. 4wk EPS
Change (FY09) | Revisions
Ratio | Firms With FY09
EPS Increase | Firms With FY09
EPS Decrease |
| Energy | 4.84% | 5.03 | 32 | 5 |
| Technology | 2.65% | 3.21 | 33 | 25 |
| Materials | 1.00% | 1.13 | 10 | 12 |
| Utilities | 0.75% | 1.08 | 11 | 10 |
| Industrials | -0.71% | 0.71 | 23 | 20 |
| Health Care | -0.06% | 0.66 | 18 | 30 |
| Consumer Staples | -0.55% | 0.59 | 18 | 21 |
| Consumer Discr | -3.63% | 0.42 | 26 | 51 |
| Telecom | 1.96% | 0.35 | 3 | 6 |
| Financial Services | -2.56% | 0.25 | 26 | 56 |
| S&P 500 | -0.33% | 0.82 | 200 | 236 |
Market Cap versus Total Earnings
When making investment decisions, growth should always be looked at in conjunction with how much you are paying for a stock. Thus, it makes sense to look at the total earnings expected for a sector, relative to that sector's total market capitalization. This is basically a variation on looking at the P/E.
The chart below shows the share of total earnings for 2007, 2008 and 2009, as well as the share of total market capitalization for each sector (the final bar shown). Since the S&P 500 is a market cap weighted index, this is the same as its index weight. On the chart below, the difference between the sizes of the first three bars shows if a sector is gaining or losing 'earnings share'. The difference between the final bar and the first three bars shows if the sector is selling for an above or below market P/E. If the final bar is smaller than the other bars, the sector is selling for a below market P/E. However, as opposed to just showing the sector P/Es, it also shows the relative importance of the sectors to the overall index.
For years, the Financials were the dominate force in the market, both in terms of market cap, and even more so in terms of total earnings. They have now been dethroned on both counts. On the Market cap front it just slipped to third place behind Energy. Still, despite their current problems, the Financials are still a very significant influence on the market. However, it is now extremely likely that they will lose the earnings crown this year to the Energy sector. Even with all the disasters in the sector, for 2007, the Financials accounted for 22.0% of the total net income for the S&P 500. In 2008, that is currently expected to decline to 15.0% before rebounding to 19.3% in 2009. However, in recent years the sector has accounted for well over a quarter of all earnings.
Energy has usurped the crown this year, with its earnings share climbing to 19.7% from 15.7% in 2007. However, analysts expect a Financials restoration next year, with the sectors share rebounding to 19.3% while Energy slips back to 18.2%.
On the market cap (and index weight) front, Tech overtook the Financials a little over a month ago and currently stands at 17.1%. Energy, moved into second place this week when it comes to index weight at 15.2%. The Financials have plunged to 14.2% of the index. As recently as the end of February, Financials had a 17.2% index weighting versus 15.7% for Tech and just 13.0% for Energy.
Given the ongoing estimate cuts in the sector, and the estimate increases in the Energy sector, I suspect the Energy sector might just keep its earnings crown in 2009 as well, but that is a long shot prediction. Most analysts are using very conservative pricing assumptions in their forecasts for the Energy sector (relative to that implied in the futures market), so earnings estimates still have lots of room to rise.
Keep in mind that these numbers are snapshots, when you should be thinking about a movie. At the end of February (the first time we had a complete read on 2009), the Financials were expected to gather 22.1% of all earnings for 2008, and Energy was expected to only get 16.0%. For 2009, the expected earnings shares were 15.0% for Energy and 22.4% for Financials. In general it seems as if the Energy sector is consistently gaining 0.1% of share for each year every week, with a similar decline for the Financials. If those trends continue, then Energy could be as dominate on the earnings front in 2008 as the Financials were in 2007, and the Financials could slip into third place in total earnings behind Tech.
For many years Financials were clearly the dominate factor in the overall market, despite generally selling for below market P/Es. Based on 2008 earnings, the Financials have a P/E of 13.6x and based on 2009, only 8.9x. However given the pace of estimate cuts in the sector, the true P/E is probably higher since the actual earnings will be significantly lower.
Energy has just taken the throne as the cheapest based on 2008 earnings trading at 11.0x, and 10.0x based on 2009 expectations. The Tech sector is far and away the most expensive in the market, trading for 18.0x 2008 and 15.3x 2009 expectations. Keep your eyes on the revisions. Unless the spreading of economic weakness to the rest of the world causes oil prices to plunge (and the recent trends are very much in the other direction), you can have much more confidence in Energy earnings forecasts actually being achieved (or exceeded) than is true with the Financials.
The S&P 500 as a whole is trading for 14.3x and 11.9x, 2008 and 2009 earnings, respectively. Based on a blend of 60% 2008 earnings and 40% 2009 earnings; that translates to a 7.51% earnings yield, which looks extremely cheap relative to a 3.97% ten year T-note. Even against the AA-corporate bond yield of 6.48% it looks attractive. However, the current level of expectations for corporate earnings still implies that profits will stay well above their historical averages as a share of GDP. That would be an exceedingly rare occurrence during a recession. The comparison between the earnings yield on the S&P and the 10 year T-note is in my opinion more a reflection of the extreme unattractiveness of long term T-notes at this point than stocks looking particularly cheap in general, however there are attractive stocks out there.
It appears that the flight to quality has caused a massive bubble in the price of T-notes. This is far and away, in my opinion, the most significant bubble in the market today, not the price of oil. The prices are hard to justify given the risk that the massive injections of liquidity by the Fed to ameliorate the credit crunch will end up fueling the fires of inflation.
Neil Malkin contributed significantly to this report.
Data in this report, unless stated otherwise, is through the close on Thursday 6/26/2008
