Tuesday, February 2, 2010

Downunder Daily Good Report, as Expected

The December quarter S&P 500 reporting has been very good. Wall Street, however, has not been. It seems that the good news on earnings has been trumped by adverse news elsewhere (Asian tightening, sovereign risk, bank regulation). It may also be a hint that the 2010 upside ‘surprise’ is already in the price.

It’s been a good S&P 500 reporting season. With 207 companies reporting (55% of market capitalization), earnings have beaten expectations by 20% (on a dollar-weighted basis). Financials have beaten expectations handsomely: They were expected to lose money, but have made some (US$7.6bn more than expected so far). Non-financial earnings have also beaten forecasts, by 9%.

The surprise is as broad as it is deep: 58% of companies have beaten forecasts by at least 5%, and only 17% have missed by 5% or more (the lowest since June quarter 2004). Broadly speaking, cyclicals have reported the biggest surprise (Exhibit 1). Note that companies where foreign markets account for less than 20% of total sales have beaten by more (36%) than those where foreign sales are over 20% (8%).

As important, this reporting season – unlike its recent predecessors – has seen revenues surprise on the upside (by 2.9% for non-financials). For most of 2009, earnings had exceeded expectations, while revenues had fallen short – implying that the surprise was in the ability of corporate America to cut costs to widen margins. Stronger revenue fits with the better-thanexpected Q4 GDP data (5.7% real, 6.4% nominal).

However, companies with above-average overseas sales have tended to report the larger revenue surprises (Exhibit 2). Put another way, companies with higher overseas sales have reported larger revenue surprises, but smaller earnings surprises, than companies less reliant on foreign sales.

The market has fallen through the reporting season. However, investors did discriminate between companies that beat forecasts due to revenue growth rather than cost cuts. Exhibit 3
shows the relative performance of stocks in the three trading days after their reports.Companies that beat forecasts are on the left; companies that missed forecasts are on the right. Exhibit 4 shows an income statement for the non-financial companies that have reported so far.

Despite the significantly better-than-expected earnings numbers, earnings revision momentum is rolling over (Exhibit 5). Since the reporting season started, Q4 EPS estimates have increased by 7.7%. However, consensus earnings forecasts for calendar 2010 have risen by only 1% over the same period.

This fits with our view that the sell-side consensus already has a V-shaped earnings rebound in its forecasts. The consensus got the V-shaped bounce in Q4 – for GDP and earnings – but because that’s what was expected, no material upgrades have been required. Our macro team doesn’t expect a sustained V-shaped recovery. The December quarter GDP outcome is the best quarter we expect to see in this expansion.

This gap between what we think is likely and what the market now expects threatens to trigger a material correction later in the year, in our view. However, as we noted last week, the prospect of better macro data in the near term could stabilize markets. We will look to turn more defensive when we see the leading growth indicators fade. We expect that that will happen
later in the current half-year.


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