Prepare for a Corporate Earnings Slowdown With Stocks
By Antoine Gara - 05/06/12 - 6:00 PM EDT
NEW YORK (TheStreet
) -- Since the recession, investors haven't had to worry about U.S. corporate earnings growth, even if unemployment, Federal Reserve
policy and a European sovereign debt spiral provided plenty of room for nervousness.
Deep into first quarter earnings season, U.S. companies are once again showing resilience and beating estimates. But amid the recent and sobering jobs reports, quixotic Fed messages, negative dispatches from Europe, and this past week's stock market swoon, it may be time for investors to question whether U.S. corporate earnings -- the lynchpin of an S&P 500 Index
recovery from March 2009 lows -- will stall in 2012 and 2013.
Recent comments from top investors and strategists signal a corporate earnings slowdown is coming.
| Deutsche Bank got the S&P 500 all wrong in 2011. Now, that may make the bank ahead of the curve in forecasting earnings growth.
Deutsche Bank, the biggest S&P 500 bull of 2011, and ValueAct Capital, a prominent activist hedge fund, both presented reasons why a U.S. earnings slowdown may be imminent in 2012 and 2013.
Their comments don't just counter the post-crisis drumbeat of strong earnings that drove recovering markets and outweighed a myriad of economic uncertainties like 8%-plus unemployment
: the investors present a way to navigate what may be a new stock market reality.
"Having recovered from cyclically depressed levels, S&P 500 EPS earnings per share
growth will be much slower than 2009-2011," wrote Deutsche Bank strategist David Bianco in a note this past Friday detailing the firm's outlook for the S&P 500. "Most sectors should deliver mid-cycle normal EPS in 2012 with the exception of Energy and Financials. We expect Energy to significantly over earn in 2012 and its EPS to decline in 2013. We expect Financials to under earn in 2012."
For Deutsche Bank, the biggest bull during a flat year for the S&P, the comments are noteworthy because their 2011 blown call
had little to do with a misforecast of corporate earnings, but instead, a misread of economic headwinds like U.S. political gridlock and the intensification of a European debt crisis midway through the year.
While S&P 500 earnings grew 15% to $97 per share in 2011, markets were flat because the earnings multiple that investors were willing to pay fell roughly 13% to 13 times earnings -- below Deutsche Bank's beginning of year forecast of a 16.4 price-to-earnings multiple. Still, Deutsche Bank sees the S&P rising roughly 8% in 2012 to 1475, because today's multiple may already price in more than just a slowing to single digit earnings growth. The 13x multiple suggests investor fear of a drastic earnings slowdown or even an earnings decline.
In fact, S&P gains may be more reliant on a rising earnings multiple in 2012, a part of the market recovery that's underperformed in recent years. Meanwhile, investors who sold shares in recent weeks on weaker than expected GDP and employment figures may be focusing on the wrong signals. "The upside surprises in many US economic reports, such as housing starts and retail sales, have reduced recession risk, but will not lead to faster EPS growth as these segments of GDP have limited influence on S&P 500 EPS," notes Bianco.
How can investors get ahead of the curve by preparing for an earnings slowdown?
Deutsche Bank suggests:
for dividend growth
, United Technologies
for spending efficiencies and rising energy consumption
for U.S. consumer and Asian business spending
for a depressed PE due to the riskiness of banks.
Last Monday, another set of earnings growth ideas emerged from the rarest of places -- an activist investor conference -- where conversation usually centers around curbing corporate excess and extracting share premiums by carving up or divesting underperforming corporate assets.
Jeffrey Ubben, the head of activist fund ValueAct Capital
laid out the case for why he's putting
his money in M&A and corporate spending, with the expectation that it will drive future revenue growth, something he expects to become increasingly rare in coming years.
"The scarcity in two to three years is going to be absolute growth," said Ubben during a panel discussion at the IMN Active-Passive Investor Summit in New York. After reckless corporate M&A and spending habits in the early 2000s, "investors are on the other end of the spectrum. They are afraid of capital expenditure, research & development; they just want more buybacks."
Speaking in between activists who profited from recent divestitures by Barnes & Noble
and legendary activist Carl Icahn, Ubben presented Adobe
as a tech turnaround that's poised to see top and bottom line earnings grow in coming years, pulling it from a perceived status as an underperforming PC-based Silicon Valley dinosaur.
Ubben, who holds billion dollar investments in Adobe, Motorola Solutions
and Valeant Pharmaceuticals
among a portfolio of 14 stock positions with a value of roughly $7.5 billion, according to Bloomberg
data, also told conference attendees to consider oil services giant Halliburton and commercial real estate manager CBRE
as other turnaround stories to watch for.
Taken together, the tone in comments from Bianco of Deutsche Bank and Ubben of ValueAct may give good reason for investors to seek out turnaround stocks and companies with favorable trends that may help them outperform a general earnings growth slowdown.
Already, in spite of widespread beats, earnings season is beginning to trend negatively, notes Bespoke Investment Group in a May 3 Web post. Over the first ten days of earnings season, the percentage of companies beating earnings estimates remained at near 10-year highs above 70%, but in past two weeks, the beat rate has declined to 64%, not far above a historical average of 62%. Watch to see if the trend continues, cautions Bespoke.
Investors looking for sectors that will sustain 10% to 15% growth should consider technology and industrials, according to Bianco of Deutche Bank. "Tech and Industrials should still deliver 10-15% EPS growth but the recent outsized growth contribution from certain companies in these sectors should become less dramatic," he adds.
-- Written by Antoine Gara in New York
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