“Remind people that profit is the difference between revenue and expense. This makes you look smart.”

                                                                                                          Scott Adams (Cartoonist)

Surprise, surprise, the second quarter earnings season is again producing better than expected overall results. Analysts’ earnings growth estimates for the S&P 500 are now somewhere around -3.5%, an improvement from the previous – 5.5% – the earnings contraction is decelerating. It should be noted, however, that even with massive stock buy-backs and acquisitions, earnings per share continue to shrink. In July, a Wall Street Journal article reported that “companies in the S&P 500 bought back $161.39 billion of shares during the first three months of the year, the second-biggest quarter for repurchases ever”. Howard Silverblatt, S&P Senior Index Analyst calculates that approximately 67% of the companies in the index have a lower share count than a year ago. Buybacks have played an important role in re-shaping earnings per share metrics and lifting stock prices but one can’t help but wonder how long this can last.

Although there are some companies yet to report, energy companies in the index have all announced and, as expected, had the largest negative impact on index earnings. S&P Global has energy sector earnings down by almost 87% while Factset is a tad more optimistic. Not surprisingly, upstream companies (exploration & production) were the worst performers. Ex-energy, S&P Capital IQ calculates that earnings in the quarter would have been up approximately 3%. Earnings for Materials and Financials also fell.

It should be noted that beginning September 1st, Real Estate Investment Trusts (REITs) will be separated from the Financials group and moved to their own sector. The search for yield and strength in commercial and residential real estate have benefited REITs, the best performing industry in Financials (+14% for the past 52 weeks as of 8/11/16). In fact, with the exception of Diversified Financial companies (+4% for the same period), all other financial industry classifications have negative returns.

As we mentioned in last month’s piece, Industrials are an interesting sector because of the disparate industries. There are fourteen industries ranging from Aerospace & Defense, Construction-related, Professional Services and Transportation. Some of these, such as railroads, are experiencing headwinds, while others – defense companies come to mind – are seeing earnings and revenue growth. With the majority of reports in, there seems to be a large discrepancy between calculations of year-over-year earnings growth for this sector in particular. FactSet (mix of GAAP and non-GAAP, but mostly non-GAAP submitted by analysts) has Industrials reporting declining earnings while S&P Capital IQ has a positive (Operating Earnings) EPS growth number, as does Thomson Reuters.

To us, this highlights the difficulty of valuing the market as a whole. There is a robust debate surrounding GAAP and non-GAAP reporting as even regulators start to question the ever expanding spread between these two measures. A liberal – very liberal in some cases – definition for the term non-recurring might even lead some investors astray – to the benefit of those whose compensation is dependent on stock price appreciation. Heaven forfend….

Consumer Discretionary again is again the earnings growth winner of the 10 sectors. Just this past week, the traditional brick and mortar retailers such as Kohls, Macy’s and Nordstrom all saw strong price gains after reporting better than expected results. Of course, one should keep in mind that a lot of these companies are reporting lower revenue and earnings on the back of declining comp store sales. But earnings were indeed better than expected in a lot of cases and the stocks responded. We’ll see about follow through as many of them are discounting to work down bloated inventories.

As it stands now, third quarter earnings estimates are once more negative (-1.7% FactSet), earnings growth has been pushed back to the fourth quarter. No one told Mr. Market this apparently, as Thursday’s price action pushed all three major U.S. indices to new highs. Pundits were quick to point out that this has not happened since December 31, 1999 – the tech bubble era. We don’t see that as an apt comparison based on sentiment, but we do believe that for the U.S. indices, stock prices appear over-extended based on current fundamentals.

Ironically, the defensive “bond proxy” stocks of Consumer Staples and Utilities look the most vulnerable with price-to-earnings ratios significantly higher than historical averages. However, there are always exceptions and attractive opportunities in every sector – they are just harder and harder to find. No question about it, this is a difficult investing environment with stocks and bonds both seemingly expensive. The ten-year U.S. Treasury is yielding around 1.5% and the dividend yield for the S&P 500 stands at about 2%…a quandary of risk and reward.

Margarita V. Fernandez

Vice President – Alhambra Investment Partners, LLC

“Wealth preservation and accumulation through thoughtful investing.”

 

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Margie Fernandez can be reached at:

305-233-3774

mfernandez@4kb.d43.myftpupload.com