From Q2 Macro Weakness To H2 Earnings Slump
June macro data is giving a 'cleaner' picture of the economic state of our great nation. With seasonal affectations (unusually warm weather and the rebound in auto production) out of the way, June macro data has very much surprised consensus to the downside as BofAML's economics team notes that 14 of the last 20 June indicators has come in below expectations. Over the next several weeks we will get more 'hard' data for June. The most important will be retail sales, industrial production and the durable goods orders report. Retail sales look likely to disappoint as weak chain store sales offset the modest tick higher in auto sales. And given the collapse in the ISM, we expect manufacturing production and durable goods orders to be soft. This data will determine if the FOMC has enough ammo to ease aggressively on August 1st (or wait til September 13th) which we expect to only be an extension of forward rate guidance to mid-2015 from late-2014 (and not the panacea of NEW QE). BofAML remains more concerned with the consensus outlook for H2 - particularly Q4 (with 14% YoY EPS growth expected despite just a 1% GDP growth rate) - as the recession in Europe and high level of uncertainty ahead of the US fiscal cliff will likely lead to slowing growth in H2. And for those hanging their hats on the housing recovery, it will not be enough to save the rest of the economy - Housing construction is now only 2.3% of GDP compared to more than 6% prior to the crisis. This means we need a decisive turn to significantly matter for GDP growth. In addition, we believe it would take a sustained period of price increases to reverse the negative wealth and confidence effects of the housing collapse. Households remain skeptical about the home as a store of wealth or an investment.
BofAML: Macro starting to impact micro
According to our US equity and quant strategy team, analysts started to meaningfully take down estimates in April, when US economic data began surprising to the downside (Chart 1) and as concerns around Europe and slowing growth in China reemerged. Coupled with a drop in oil prices and a stronger dollar, expectations have been driven down by macro headwinds, and guidance has started to falter. At this point, bottom-up consensus is expecting S&P 500 EPS of $25.23, representing earnings growth of 5% YoY (flat ex. Financials), which is slightly below our estimate of $25.50.
But bigger problem is the 2nd half
The US equity and quant strategy team remains more concerned with the consensus outlook for the second half of the year, particularly expectations for 4Q. Analysts expect 14% YoY earnings growth in the fourth quarter, despite the fact that our economists expect just 1% GDP growth. Estimate revisions have begun to roll over, with analysts now making more cuts than increases to EPS on a three-month basis, but we think this trend may have further to go. The US equity and quant strategy team has taken a more cautious stance on their earnings estimates for companies with high foreign or US government exposure, given the recession in Europe and high level of uncertainty ahead of the US fiscal cliff that will likely lead to slowing growth in the second half of this year.
Housing cannot save the rest of the economy
The housing market fared better in the first half of the year than other parts of the economy. Housing inventory declined as demand picked up, creating opportunity for construction and supporting home prices. Supply of existing homes tumbled to 6.6 months while supply of new homes plunged to 4.7 months. This implies that the housing market is closer to equilibrium, setting the stage for recovery in our view.
While we believe the housing market is primed for recovery, we caution that it will continue to be a slow return to normal. There are two crucial reasons to expect the housing recovery to be gradual and bumpy. First, the macro environment remains challenging with lackluster job growth, low consumer confidence and impaired household balance sheets. Second, mortgage credit remains tight, restricting the pool of potential homebuyers. We believe that the housing market can heal despite these challenges, but it will likely be a gradual turn.
Even with improvement in the housing market, it would likely not be strong enough to save the rest of the economy, in our view. Housing construction is now only 2.3% of GDP compared to more than 6% prior to the crisis. This means we need a decisive turn to significantly matter for GDP growth. In addition, we believe it would take a sustained period of price increases to reverse the negative wealth and confidence effects of the housing collapse. Households remain skeptical about the home as a store of wealth or an investment.