- Concerns over a deteriorating financial situation in Europe, combined with increased fears that a double-dip recession scenario might become a reality here in the U.S., sparked an 8.5 percent decline in the S&P 500 Index in the second half of June.
- Since July 1st, the S&P 500 Index has staged an offsetting recovery, receiving support from another round of better than expected earnings.
- Earnings results thus far have been very strong which for the first time in many quarters has proven to be the catalyst for investors to take the stock market higher.
- We see strong corporate earnings as validation of our view that the U.S. economy will continue its path to a “low and slow” recovery; and see little risk of a double dip.
As of July 27th, 179 companies or 36 percent of the S&P 500 companies have reported results. Of those, 81 percent have beat earnings expectations. This is the fifth consecutive quarter of earnings surprises above 75 percent, well ahead of the long-term average of roughly 60 percent. The level of growth delivered by companies this quarter has been much greater than anticipated. Moreover, the aggregate year-over-year growth rate is over 60 percent, far outpacing the consensus bottom-up growth estimate of 42 percent heading into the reporting season.
More than 77 percent of companies in the S&P 500 are now showing positive growth in earnings. The magnitude of the upside surprise is extremely high as well, with companies beating expectations by almost 11 percent compared to the historical average of just 3.5 percent. Further, growth is now well diversified across segments of the economy with all ten sectors experiencing positive earnings surprises ranging from 2.7 percent in consumer staples to 25.3 percent in consumer discretionary.
The quality of earnings as measured by top-line or revenue growth continues to improve. After four straight quarters of declines, revenue growth turned mildly positive in the fourth quarter of 2009, and then shot 12 percent higher in the first quarter of this year. As a result, expectations for revenue growth were fairly high going into the second quarter and the reported levels have not disappointed. Of the 179 companies to report, 68.5 percent have exceeded their consensus revenue estimate. In aggregate, they are beating estimates by an average of almost 3 percent. Over 78 percent are now showing positive growth in revenues and the rate of growth is quite high at over 10 percent (almost 12 percent if one excludes financials) which is notably higher than the 9 percent expected at the start of the quarter.
In the minds of investors, one of the most important factors this quarter has been the outlook given by corporate managements for their business going forward. While strong top-line growth would seem to suggest that current conditions are solid, investors are eager to find evidence of visibility on the future business climate. Of the companies that have reported, roughly 10 percent have raised their forecasts while just 2.2 percent have lowered guidance. Lowered forecasts have come largely from regulatory changes in the healthcare and financial sectors, while more cyclically oriented business have generally raised expectations as evidenced by very upbeat comments from companies like Intel, United Parcel Service and Caterpillar. Accordingly, industry analysts have reacted by raising their earnings estimates. At the Index level, full year estimates continue to ratchet up with 2010 forecasts now centered at the low to mid $80s and the 2011 earnings number holding steady at around $95. It is worth noting that this rise is being fueled by estimates moving up across all sectors and not just select areas of the market.
In conclusion, second quarter earnings have proven to be very strong in absolute terms and relative to both history and market expectations. These results have buoyed optimism in the near-term. Investors are now intensely focused on the outlook going forward as worries still persist about the level of growth in the second half of 2010 and next year. However, strong earnings could continue to provide support for a low and slow economic recovery during a period when the S&P 500 Index is reasonably priced at 13.5 times 2010’s earnings and 11.8 times 2011’s earnings.
Statements concerning Commonfund Group’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund Group fund. Such statements are also not intended as recommendations by any Commonfund Group entity or employee to the recipient of the presentation. It is Commonfund Group’s policy that investment recommendations to investors must be based on the investment objectives and risk tolerances of each individual investor. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund Group. Commonfund Group disclaims any responsibility to provide the recipient of this presentation with updated or corrected information.