Cutting Into Muscle - The Record Corporate Margin Juggernaut Has Just Rolled Over
In this week's chartology from Goldman's David Kostin there is the usual plethora of useful data, but two slides deserve a very special mention because with 39% of the S&P already reporting Q4 data, the implication is quite dire. If Kostin is correct, then the corporate margin juggernaut, which recently hit an all time high in Q3 of 2011, and which has for all intents and purposes been the one offset to deteriorating economic conditions, recurring Fed stimuli to the economy aside, has officially peaked and is now rolling over. This has huge implications for virtually everything, as it means that after 3 years of layoffs, corporate America has finally cut through all the fat and is now officially chopping into muscle with every additional layoff. It also means that going forward no matter how many workers are laid off, the corporate margin rate wil not increase. Furthermore, if Bernanke or Draghi officially launch another inflationary easing episode which more than anything exports inflation to China, which in turn reexports it back to America in the form of rising COGS, margins will compress even more. In other words, the US economy, which sadly has been "defined" as the Russell 2000 and/or the DJIA, is tipping over. And with companies posting a near record low positive earnings surprise ratio, we are once again amazed how yet another Goldman team may have well called the absolute peak in the market with its long Russell call from two days ago.
The two smoking guns:
And another chart which confirms that the good times are now over:
And the full weekly commentary from Kostin:
S&P 500 index was unchanged this week despite two major positive news announcements that might have been expected to spark an equity rally: Stellar quarterly results for Apple (AAPL) and the FOMC announcement that the fed funds rate would remain exceptionally low “at least through 2014.”
A conditional commitment by the US central bank to follow a zero interest rate policy (ZIRP) for three more years and stocks remain flat? S&P 500 has risen 5% YTD but the absence of a rally this week suggests investors had already priced in an extended easing cycle. In a low-yield world, our dividend yield and growth basket should outperform (<GSTHDIVG>).
The Fed now explicitly intends to target inflation at 2% as measured by personal consumption expenditures (PCE) price index. Goldman Sachs Economics expects another round of asset purchases to be announced by around midyear. Based on the central tendency of the Fed’s economic forecasts, the core of the FOMC is at least as dovish, perhaps even more dovish, than Goldman Sachs Economics had believed previously. See US Daily: A more transparently dovish FOMC, January 26, 2012. Less positive macro news this week included 4Q 2011 GDP growth of 2.8% that missed consensus expectations of 3.0%.
AAPL posted stunning results with sales surging 73% to $46.3 billion and EPS rising 115% versus the comparable year-ago quarter. Net margins reached 28% and the stock alone contributes 44 bp to overall S&P 500 net margins. AAPL shares rose 6% this week. Goldman Sachs analyst Bill Shope has a $600 twelve month price target reflecting 35% potential return.
A total of 195 firms in the S&P 500 have now released 4Q 2011 results representing 53% of the equity cap. Below we highlight eight takeaways:
1. On a quarterly basis, 4Q 2011 EPS are expected to grow by 11% year/year while sales for S&P 500 (excluding Financials and Utilities) will rise by 10%.
2. On a trailing four quarter basis, 4Q 2011 will establish a new EPS peak of $97. Trailing four-quarter net margins for the S&P 500 (ex Financials and Utilities) have been hovering at peak levels of 8.9% for the past three quarters. Full-year 2011 EPS will be 16% higher than 2010 ($84) and full-year sales (excluding Financials and Utilities) will be 12% above last year. S&P 500 revenues including Financials and Utilities have not yet returned to peak levels reached in 2008, but 4Q 2011 sales excluding Financials and Utilities may reach a new quarterly peak level.
3. The percentage of firms beating consensus EPS expectations by more than one standard deviation (our definition of a positive surprise) is well below the historical average. The number of firms missing by more than one standard deviation is above the historical average. The ten year historical average of beat and misses equals 41% and 13%, respectively. So far this quarter just 24% of firms beat expectations and 17% have missed.
4. On an aggregate basis, reported results represent a 3% upside EPS surprise for the quarter ($0.45 per share). However, estimates for firms yet to report fell by 2% resulting in 0.9% change to S&P 500 4Q EPS. The median surprise over the past ten years has been 1.6%.
5. The Information Technology sector contributed nearly all of the S&P 500 upside EPS surprise ($0.43 of $0.45 total). Industrials and Financials contributed about 40% and 30%, respectively, or $0.18 and $0.14. Energy surprises have been negative, lowering the index aggregate by $0.26.
6. Individual companies matter. AAPL represents 18% and 26% of the Information Technology sector’s market cap and expected 4Q 2011 earnings, respectively. The Information Technology sector should grow earnings by 21% year/year, but by just 5% excluding AAPL. Apple is likely to be the top contributor to S&P 500 EPS for this quarter. 4Q 2011 will represent the first time since 2003 that Exxon (XOM) is not the top S&P 500 EPS contributor.
7. Since the start of earnings season, bottom-up consensus full-year 2012 estimates have declined by 0.5% to $106. Our top-down forecast remains $100. Revisions are largest in Materials (-3.5%), Energy (-2.5%), and Financials (-2.3%). Information Technology revisions have increased by 3% and Industrials revisions have been flat.
8. Year to date, 51 firms representing 13% of 2012 S&P 500 earnings have issued full-year EPS guidance. The midpoint of guidance is slightly negative relative to consensus estimates. Firms like JNJ, GD, CB, RTN, KMB, and EBAY guided below consensus while BA, JCP, CAT, TXT, BWA, and APH guided above expectations.
Next week represents the third of the three major weeks of the 4Q reporting season, with 99 firms representing 18% of the S&P 500 equity cap scheduled to release results. 40% of Energy and Health Care market cap reports next week. Key stocks to watch include: XOM, PFE, MRK, QCOM, UPS, AMZN, LLY, and DOW. See pages 5-7 for next week’s calendar.