MorningWord 9/23/13: The new high in the SPX on Wednesday as a result of the Fed’s decision to stay the course with QE seemed fairly silly when you consider the reason for the Fed’s inaction; specifically their continued concern about the pace of the economic recovery and their downgrade of growth expectations for the balance of 2013 and for all of 2014. The fact of the matter is, the Fed has routinely overestimated their forecasts for growth throughout the recovery of the last few years which has caused them on numerous occasions to reset lower prior forecasts. Regardless of the routine over-assessment (good discussion here on the Pragmatic Capitalism blog) equity investors continue to demonstrate their preference for the pain meds with side-affects that are known to cause irrational exuberance as it pertains to financial risk taking as opposed to a more painful yet far more sustainable cure for economic economy’s ills.
Let’s be honest people, there were few on the planet back in 2009/2010 who disagreed with the intention of QE, when the very framework of our financial existence was in danger, but now some 4 years later, with the pace of asset purchases as high as they have been throughout the period on a monthly average, it is hard to see the continued benefit when the only inflation the Fed seems to be causing is in the stock market and select real estate markets.
What’s The Driver Now??
With the SepTaper NOT underway, and just a week left in Q3, investor focus may quickly turn away from the Central Bank towards corporate earnings, with particular interest in the outlook for the balance of the year. Often times it can be easy to write off the quarter just completed results as backward looking but with much of the 2013 equity rally the result of multiple expansion rather than proper earnings growth, Q3 disappointments could be met with downward volatility (at least on a stock by stock basis) as stocks appear to be priced for perfection.
On Friday, FactSet Research issued their weekly Earnings Insight piece where they highlighted Wall Street analysts similarity to be overly enthusiastic when it comes to forecasts (in this case) for corporate earnings growth as opposed to the Fed’s inability to come close on GDP. Per Factset:
- Earnings Growth vs Revisions: The estimated earnings growth rate for Q3 2013 is 3.4%. On June 30, the earnings growth rate for Q3 2013 was 6.5%. All ten sectors have recorded a decline in expected earnings growth over this time frame, led by the Materials sector.
- Earnings Guidance: For Q3 2013, 88 companies have issued negative EPS guidance and 19 companies have issued positive EPS guidance.
- Valuation: The current 12-month forward P/E ratio is 14.6. This P/E ratio is well above the 5-year (12.9) and 10-year (14.0) averages
Lastly, lets not be confused by the continued financial engineering that appears to be reaching fever-pitch by companies levering up and buying back their stock hand over fist (in many instances at 52 week or all time highs) to help massage the paltry earnings growth we are seeing (and to offset the exercise of options by executives). I get it, in many instances companies with strong free cash flow generation and solid balance sheets would be foolish not to lock in low long term borrowing rates and retire shares to enhance earnings per share, but let’s not forget that revenue growth is expected to be just a tad above flat year over year and far below earnings growth, per FactSet:
The estimated revenue growth rate for Q4 2013 of 0.9% is expected to be well the below estimated earnings growth rate of 10.3%
While I would love to give C level suites of the S&P 500 companies props for their timing in buying back their own shares, but data does not exactly suggest that they are any good at it. So here we are, 1% from the all time highs, and forget the Fed, Syria, Congress, the markets are about to get hit with the very data that they are most often expected to trade on, corporate earnings, at a time where the outlook couldn’t be cloudier relative to performance.
But don’t take my word for it. Here’s one of the smartest money managers of the past 30 years, Stanley Druckenmiller, detailing the risks of the Fed’s action on CNBC last week (8 mins in):