Tuesday, December 13, 2011

S&P 500 Sectors’ Performance & Earnings

In my meetings with our accounts in Kansas City last week, everyone said that they are very tired of the volatility in stock prices this year. Don’t stare too long at the chart above of the year-to-date performance of the S&P 500's 10 sectors. It can make you very dizzy. The volatility has been especially intense since late July. That’s when the 10 sectors’ respective volatilities became increasingly correlated while at the same time Stable sectors began outperforming Cyclical ones, in a significant reversal of their relative fortunes so far this year. Here are the latest derby results ytd as of yesterday’s close: Utilities (9.7%), Consumer Staples (7.3), Health Care (5.6), Consumer Discretionary (4.5), Information Technology (2.6), Energy (0.8), Telecom Services (-3.1), Industrials (-5.0), Materials (-12.8), and Financials (-20.2).

Since the last week of July through the start of December, there has been a noticeable drop in consensus expected earnings growth for the 10 sectors in 2012. The most pronounced declines have been for Energy (from 11.9% down to 2.8%), Materials (14.2% to 10.6%), Industrials (18.0% to 13.4%), Telecom Services (13.5% to 7.6%), and Financials (35.9% to 23.5%). The other sectors’ earnings growth expectations have been relatively more stable. Earnings growth for the overall S&P 500 for next year has declined from a peak of 15.2% during the week of July 22 to 10.1% in the latest week.

These earnings revisions help to explain some of the reversals of fortune in the sectors’ performances since the summer. The extreme volatility reflects a number of other factors too. Investors’ sentiment has been buffeted by the ongoing crisis in Europe. The Cyclical sectors all tend to rise in lock step when Europe’s leaders are scrambling to formulate yet another plan to clean up their mess. Then when the latest plan is announced and found to be lacking, the Cyclical sectors all go down together--while the Stable ones outperform, but head in the same direction. Financials tend to be among the worst performers during these letdowns. The widespread and highly correlated volatility on a short-term basis can also be attributed to high frequency trading and the impact of ETFs, especially leveraged ones. Needless to say, all these factors are likely to continue to buffet stock prices in the coming year.

Meanwhile, one source of underlying stability has been industry analysts’ expectations for total S&P 500 earnings this year and next year. This year’s estimate has ranged between $95.97 and $100.09 per share since the beginning of the year. The 2012 estimate has ranged between $107.95 and $113.83 over this same period. Next year’s estimate mostly fell from the top of this range to the bottom of this range since the beginning of the year, but it has stabilized around $108 over the past couple of weeks. That’s noteworthy given the bad news coming out of Europe.

Then again, there was some bad news coming out of some big companies in recent days that may push the 2012 consensus estimate lower again. That wouldn’t surprise Joe and me since we are forecasting that earnings will be $100 next year. Executives at DuPont, 3M, and Texas Instruments warned that they are seeing signs that their customers are trimming their inventories in anticipation of weaker sales. One of the concerns is a slowdown in the European auto industry. Another problem is that the shortage of disk drives following flooding in Thailand is depressing the demand for semiconductors. Intel announced yesterday that its revenue this quarter would be lower than previously expected--at $13.7 billion versus the earlier projected $14.7 billion.

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