S&P 500 Earnings & the M-PMI

October should provide a very interesting Q3 earnings season. We have been very bullish on the past nine earnings seasons. We have our concerns about the tenth one. We won’t be surprised if there are more negative earnings surprises this time and lots of cautious guidance about Q4’s outlook. The biggest negative is likely to be that sales and earnings in Europe slowed significantly during the quarter, and are likely to worsen over the rest of the year.

US domestic sales and earnings could also be disappointing given the weakness in all the Fed and ISM surveys of business during July and August. There is a strong correlation between S&P 500 operating earnings on a year-over-year basis and the ISM purchasing managers index (PMI) for manufacturing. This index dropped from the most recent cyclical high of 61.4 during February to 50.6 during August. This suggests that the year-over-year growth rate in S&P 500 operating earnings is heading towards zero, unless there is a surprising rebound in the PMI over the rest of the year.

S&P 500 operating earnings was $24.85 per share during Q2, up 18.9% y/y. Industry analysts are currently forecasting $25.04 for Q3, which would be up 15.1% y/y. They expect earnings to be up 15.1% during Q4 and 13.7% during all of next year. Again, these forecasts are likely to be too optimistic if purchasing managers indexes remain subdued in the US and if European economies remain depressed. We are predicting that earnings will be up only 5.3% next year.



The dollar might soar again. Three years ago, Lehman and AIG blew up. That led to a flight away from counterparty risk and a flight to quality. The US Dollar Index soared from a low of 71.99 during the summer of 2008 to a peak of 89.54 on March 4, 2009. During the first round of the European sovereign debt crisis, the index rose from 74.95 on November 30, 2009 to 88.71 on June 7, 2010. Signs of financial stress are mounting again, and could once again be bullish for the dollar. Let’s review:

(1) Foreign official and international accounts deposited $102.8 billion at the Fed, up sharply from $57.6 billion at the start of the year, and well above the previous high of $88.9 billion during the week of January 7, 2009.

(2) The flight to quality is most apparent in the plunge in 10-year government bond yields around the world to record lows. This morning these yields are at 0.92% in Switzerland, 1.00% in Japan, 1.66% in Sweden, 1.71% in Germany, 1.89% in the US, 2.11% in Canada, 2.19% in the UK, and 2.47% in France. On the other hand, yields are much higher among the credit-challenged governments of Spain (5.19%), Italy (5.44%), and Greece (18.56%).

 

(3) At the end of last week, the high yield spread in the US widened to 651bps from 416bps at the beginning of the year. It is the widest since November 30, 2009. This spread is an excellent leading economic indicator and suggests that the outlook is deteriorating.

S&P 500 Sectors: Forward & 2012 Earnings

Today’s charts show the percentage changes in the S&P 500’s forward earnings and 2012 consensus estimates since the beginning of the year for the 10 sectors. Keep in mind that as we approach the end of the year, forward earnings will converge to equal the 2012 estimate at the end of this year. Through the week of September 1, forward earnings for the sectors are mostly up year-to-date as follows: Energy (33.7%), Materials (21.4), Industrials (15.8), Information Technology (15.5), Consumer Discretionary (10.6), Consumer Staples (6.2), Health Care (5.1), Financials (4.2), Utilities (-0.9), and Telecommunication Services (-1.0).

 

A similar pattern can be seen in the 2012 estimates. However, estimates for Financials (down 6.3% ytd) and Telecommunication Services (down 9.8% ytd) have been falling since the start of this year.



Global Purchasing Managers Indexes



The 4% jump in Germany’s industrial production during July was very good news. But it was also old news. Germany’s manufacturing purchasing managers index (M-PMI) fell to 50.9 in August, the lowest reading since September 2009 and well below the most recent cyclical peak of 62.0 during April. The other major M-PMIs all confirmed that global manufacturing growth stalled in August. We construct a Global M-PMI by averaging the indexes for the US, the UK, the Eurozone, and China. This super index fell to 49.9 in August from 50.3 in July. It is down from the most recent cyclical peak of 58.4 during February.


Does this mean that the global economy is on the verge of double dipping? I don’t think so. Rather, I expect that M-PMIs may continue to fluctuate north of 50 over the rest of this year into next year. Keep in mind that the PMIs are diffusion indexes. That means they cycle. Readings of 50 mean that most purchasing managers are saying that business was as good this month as it was last month.

 



Meanwhile, purchasing managers in nonmanufacturing industries remain relatively upbeat. The Global NM-PMI was 53.4 in August. That’s down from 54.8 in July, and the recent cyclical peak of 57.9 during March. But it is solidly above 50.





US Employment Indicators

You don’t need me to tell you about all the bad news in August’s employment report. So let’s try hard to find some of the good news in that report released by the Bureau of Labor Statistics (BLS). Private sector payrolls are up 142,400 per month on average over the past 12 months. That’s certainly subpar, but a recovery nonetheless. According to the ADP survey of private payrolls, employment rose 91,000 during August, outpacing the official increase of 17,000. During the first eight months of this year, these payrolls are up 1.16 million with small, medium, and large companies adding 603,000, 508,000, and 45,000 to their payrolls.

Private sector payrolls bottomed during February 2010. They are up 2.4 million over that 18-month period. Over the same period of the previous recovery in this measure of employment, it rose 2.5 million.





The pace of hiring could actually improve in coming months. The Monster Employment Index rose 3 points in August to 147, the highest reading since October 2008. Last month’s advance was led by increases in natural resources, healthcare, and retail trade. The following industries were at cyclical highs during August: manufacturing, construction, transportation & warehousing, retail, information, educational services, and healthcare & social assistance. While the hiring situation could deteriorate rapidly, it did not do so in August.