It is a mixed bag so far this earnings season with strong earnings and lackluster revenues. As of Thursday, July 22, 2010, a quarter of the S&P 500 companies have reported with 81% of those companies reporting a growth in earnings per share. The average reported growth is 55%. Additionally, of those who have reported, 86% have beat expectation. However, only 77% of the companies have reported sales growth, with a low average sales growth about 9%.
International Business Machines (NYSE: IBM) reported rather boring—but not terrible—numbers this week, with top line revenues less than expected. The company had a 12% lower than expected rate for contract re-signings. We feel the market has come to expect more from IBM since they have beat expectations for nearly 30 quarters in a row.
United Parcel Service (NYSE: UPS) report shows the company is spending money to bring planes online. The company posted solid earnings and revenue and indicated that capital expenditures are growing. Their international volumes are up, and domestic volumes are up 7%. Overall, they reported profits jumped 70%.
We think investors are confusing asset values with how the overall economy is doing. In some parts of the country, home values are down 25% from their peak, but that is not the same as economic growth. If you look at the numbers the railroads are posting, you will see that they are moving a lot of freight—a sign that products are moving and that the manufacturing sector is doing well. Our concern is in the question, “How much of this is inventory rebuilding versus sustainable growth?”
We have been watching the semiconductor book-to-bill ratio—the technology industry’s demand-to-supply ratio for orders on a “firm’s book” to number of orders filled. It has been above 1, which is parity, for the past 12 months. To us, this is a good sign. Semiconductor companies do not build inventory or increase capital spending unless they feel there is a long-term trend. We see that in Intel’s (NASDAQ: INTL), Cisco Systems’ (NASDAQ: CSCO) and Texas Instruments’ (NYSE: TXN) numbers. This shows us the growth in technology is sustainable.
It was 1993 to 1995 when corporate profits last outperformed the markets. The S&P was up 5.25% but corporate profits were up 14% on an annualized basis. Now, the S&P is up 12.12% since fourth quarter 2009 and corporate profits are up 50%. The S&P price to earnings ratio is 11–11.5, but the normal ratio is around 15 on a forward basis.
We feel we are seeing a contraction because of the uncertainty coming out of Washington. We are in a record-low interest rate environment. Traditionally when interest rates go down, P/E ratios ought to go higher. We are contracted from historical averages. We feel businesses are looking for clarity from Washington. They want to understand where the tax code is going, what the new regulatory environment will bring. Companies are not going to venture into new markets or launch product lines until they have clarity of how politics will play out in the next few years.
If the GOP wins the House and wins enough seats to filibuster in the Senate, it is anybody’s guess where the market will go. We still believe the S&P will finish the year at 1,330. After the 1994 election, the S&P dusted corporate profits with assets appreciating significantly. We assume the market is pricing in uncertainty now. If we get clarity in the next election, we will have an environment that is conducive for valuations.
Economist Michael O’Rourke recently wrote how before, when all signals pointed to bad debt market and showed a problem brewing in Financials with the interest-only loans, the market kept going up. Now, we find ourselves in the opposite position with sectors reporting financial strength and the market acting schizophrenic at best.
Putting teeth to that argument, Wells Fargo (NYSE: WFC) reported non-performing loans decreased and beat earnings by 34% relative to analysts’ expectations. Their whole story was based on credit getting better. But who is Wells Fargo? Wachovia, who bought Golden West Financial, the original “Pick a Payment Loan.”
What can we take from that? Financials are getting better