Comstock Partners, Inc.October 25, 2012
Downward Earnings Revisions Are A Game Changer
In the face of a world-wide slowdown, the European sovereign debt crisis, dysfunction in Washington and the fiscal cliff, two major props have been behind the upward move of the market----the vigorous gains in corporate earnings and the Fed's determination to keep monetary policy ultra-easy into mid-2015. Now one of these bulwarks----earnings----- are in the process of reversing to the downside, leaving only the Fed to stem the tide against the force of household debt deleveraging.
For those companies reporting 3rd quarter results, earnings were down an average of 3.9% and revenues up only 0.4%. Moreover, results for the 4th quarter may be even worse. Of 39 S&P 500 companies providing 4th quarter guidance, 35 indicated results below the current consensus while 25 of 28 forecast that revenues, too, would fall short of the consensus.
Companies cutting 4th quarter estimates included Caterpillar, 3M, DuPont, Texas Instruments, United Technologies, Advance Micro Devices, Microsoft, IBM and Intel. Consensus estimates for the 4th quarter now look for a year-over-year earnings increase of 8.3% and a revenue increase of 2.7%. With the current round of downward revisions, and probably even more ahead, these estimates are sure to come down. In addition the global slowdown makes it highly likely that 2013 earnings estimates are too high as well, indicating that P/E ratios are significantly higher than the "Street" believes.
At the same time the U.S. economy continues to slog along at an inadequate pace. Although a few economic indicators have come in higher than expected, the major determinants of economic growth continue to lag. Real consumer expenditures have increased at a paltry 0.1% average annual rate since March. Headline new orders for durable goods were up 9.9% in September only because of the month-to-month volatility of transportation orders. Core new orders were actually flat, and more importantly, are down a whopping 7.4% from a year earlier, meaning that industrial production, which has been flat for the last seven months, is likely to fall in the months ahead.
That leaves only the Fed as the last stand against a market meltdown, as bullish observers continue to repeat their mantra, "Don't fight the Fed." However, as we've stated previously, the Fed has used all of its conventional tools as well as some not so conventional, and is out of ammunition. Significantly, the market peaked the day after the announcement of QE3, indicating that the act may have been fully discounted by the run-up preceding it. Furthermore, if Gov. Romney wins the election, the pressure on the Fed to pull back on its policy of ease may come under severe pressure, thereby removing the last excuse for investor optimism. In our view, the market is in for a rough period in the months ahead.