What Q2 Earnings Say About the Year End

10/01/2013 9:00 am EST

Focus: STOCKS

Sam Stovall

Chief Investment Strategist, CFRA Research

S&P Capital IQ's chief investment strategist Sam Stovall shares his perspective on what the recent earnings season say about the stock market and where it's headed into year-end.

SPEAKER 1:  My guest today is Sam Stovall.  Hi, Sam, and thanks for joining me.

SAM:  My pleasure, Nancy.

NANCY:  The markets have been great and earnings didn’t seem to be too bad for second quarter.  They seem to be better.  I think 72%/76% of the companies actually surpassed expectations from the last thing that I saw.  What is your feeling going forward into third quarter?  Do you think we’re inching forward or are we going to have a pullback in earnings?

SAM:  Well, I think that we’re inching forward.  Heading into the second quarter reporting period, S&P Capital IQ consensus estimates called for about a 2.8% gain in earnings.  We ended up with a 4.8% gains so a little bit better than anticipated.  You’re right, certainly more than the 10-year average of 62% beat rate was eclipsed this time.  Let’s face it, companies seem to know how to manage expectations and they’ve done that very well.

NANCY:  Yes.

SAM:  Going into the fourth quarter, right now the expectation is again for 4% to 5% increase in earnings so if we end up starting the quarter with that kind of a number maybe we end up with 6%.  A slow upward trajectory.  I would tend to say earnings are like a low-flying recovery and they are susceptible to dangerous down drafts, but hopefully the higher we go the less vulnerable we become.

NANCY:  The market you know normally obviously anticipates earnings.  Do you think we’ve gotten too far ahead of earnings at this point in time or are we playing catch up or are we okay?

SAM:  We did not get too far ahead of currently projected earnings, but I think investors might be worried that projected earnings have to come down a bit.  People are blaming the tapering as to the reason why the market is declining.

NANCY:  Sure.

SAM:  Maybe so because we’re also seeing the yield on the 10-year note creep up to 2.8%, but that’s been out there for a while.

NANCY:  Yes.

SAM:  My feeling is okay, then it’s going to be done pretty soon as a catalyst for what’s causing a concern.  If we tend to shift from a liquidity-led market to a fundamentally driven one, but now we start having questions about the sustainability of earnings growth that I think could be a problem.  At the same time, the Fed watches the same data that we do.

NANCY:  Probably better.

SAM:  Sure, if they end up saying it’s all going to be data driven, a lot of people are saying that FOMC stands for Federal Open Mouth Committee.  Really they’re saying we think the economy is going to do well so what we may start to taper.  On the other hand, if it doesn’t do well based on the data then we won’t.  That’s not speaking out of both sides of the mouth; that’s giving two different scenarios that people choose to feel confused about.

NANCY:  That’s right.  Bottom line in terms of valuation of the market is there still?

SAM:  Valuation, if we look at a trailing basis we’re anywhere from 5% to 9% at a discount to trailing operating earnings which some people are earnings before bad stuff as well as gap earnings which includes everything.  Then looking forward, if we went back to the average PE of 16 times projected earnings during this lost decade since 2000, the S&P should be trading at 18.40 not closer to 16.40.

NANCY:  I like those numbers.  Well, thanks for being here.

SAM:  My pleasure, thanks.

NANCY:  Thanks for joining us at the MoneyShow.com video network.

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