Record Profit Upgrades Clash With El-Erian's Fizzling Recovery
Mohamed El-Erian of Pacific Investment Management Co. says shares are no bargain as the recovery fades. Photographer: Gillianne Tedder/Bloomberg
July 6 (Bloomberg) -- Tommy Huie, president and chief investment officer of M&I Investment Management Corporation, talks with Bloomberg's Julie Hyman about the outlook for the U.S. economy and corporate earnings, and M&I's equity investment strategy. (Source: Bloomberg)
July 6 (Bloomberg) -- Jeremy Zirin, senior equity strategist at UBS Wealth Management, talks about the outlook for U.S. corporate earnings, stocks and the economy, and his equity investment strategy. Zirin speaks on Bloomberg Television's "InBusiness With Margaret Brennan." (Source: Bloomberg)
July 1 (Bloomberg) -- Chris Hyzy, chief investment officer at U.S. Trust Co., talks about the recent decline in the stock market and the outlook for the U.S. economy. Hyzy speaks with Margaret Brennan on Bloomberg Television's "InBusiness." (Source: Bloomberg)
Analysts are raising earnings estimates for U.S. companies at the fastest rate since at least 2004 just as stocks post the biggest losses in 16 months on concern that the economy will sink back into a recession.
Profit for Standard & Poor’s 500 Index companies will jump 34 percent in 2010, compared with a projected gain of 27 percent on March 29, according to more than 8,000 estimates compiled by Bloomberg. The revision, the most during any quarter in at least six years, came as lower-than-forecast home sales, manufacturing and private-sector job growth sent the benchmark gauge for American equities down 16 percent since April 23.
Rising income and falling prices may mean shares are cheap enough to rise, says Philip Orlando of Federated Investors Inc., after $2.48 trillion was erased from equities and as bonds beat stocks by the most since 2001. Mohamed El-Erian and Bill Gross of Pacific Investment Management Co. say shares are no bargain as the recovery fades. Traxis Partners LLC’s Barton Biggs sold almost all his U.S. technology shares last week.
“The psychology of the stock market couldn’t be worse, yet the valuation probably couldn’t be a whole lot better,” said Orlando, the New York-based chief equity market strategist at Federated, which manages $350 billion. “Because corporate earnings estimates are rising, there’s a significant valuation imbalance that suggests later this year stocks are going to start going up again, and they’ll probably go up sharply.”
Profit Protection
The improving profit outlook failed to protect investors in the second quarter as the S&P 500 plunged 12 percent, the most since 2008. Wall Street firms raised 2010 estimates for U.S. Steel Corp., Wynn Resorts Ltd. and Citigroup Inc. at least 78 percent during the period and the shares lost an average of 15 percent, according to data compiled by Bloomberg. Five U.S. companies a day boosted profit projections last quarter, compared with an average of five that cut them, the data show.
Through July 2, the S&P 500 slumped 9 of the prior 10 days, losing 5 percent last week after the Conference Board cut its estimate of Chinese growth and U.S. government reports on employment and manufacturing trailed the median economist projections. The stock index slipped 0.5 percent to 1,022.58 on July 2 after the Labor Department said private employers added 83,000 jobs in June, 25 percent fewer than economists predicted.
The S&P 500 rallied 0.5 percent to 1,028.06 at 4 p.m. in New York today.
Biggs Selling
Biggs, whose stock investments in March 2009 gave New York- based Traxis a 38 percent gain last year, said concerns the economy will contract spurred his technology sales last week. The Commerce Department said purchases of new homes fell 33 percent in May to an annual rate of 300,000, the least on record. The Institute for Supply Management’s manufacturing gauge expanded in June at the slowest pace this year.
Buying shares after they fell to a 12-year low pushed Traxis’s gain to almost three times the industry average last year, according to Chicago-based Hedge Fund Research Inc. While Biggs cut his equity holdings by almost half last week, he said the second recession in three years isn’t inevitable and that stock gains usually slow at this stage of an economic recovery.
The U.S. stocks rally since March 2009 and the retreat that began two months ago mimic the pattern set in 1982, when a bull market that lasted five years began, according to Birinyi Associates Inc. While the Russell 2000 Index of small companies tumbled as much as 20 percent since April, the research firm says the S&P 500 may not follow it into a bear market. Since 1940, the S&P 500 has avoided long-term declines when the Russell 2000 plunged 20 percent at least five times, according to Westport, Connecticut-based Birinyi.
GDP Expansion
The U.S. economy may expand 3.2 percent in 2010 and 2.9 percent in 2011, based on the median estimates from economists polled by Bloomberg.
Earnings season starts next week with Alcoa Inc.’s report on July 12. The New York-based aluminum producer is forecast to post second-quarter profit of 13 cents a share, recovering from a loss a year earlier, according to estimates compiled by Bloomberg. At least 158 S&P 500 companies, representing about 48 percent of the index’s market value, are set to provide results in the two weeks starting July 12, Bloomberg data show.
Analysts are waiting too long to incorporate a slowdown in the U.S. economy into their estimates for company earnings, according to El-Erian. The chief executive officer of Newport Beach, California-based Pimco says the world is in a “new normal” of mounting budget deficits, heightened regulation and weaker economic growth, which will depress equity returns.
Structural Headwinds
“The second-quarter increase in analyst estimates reflected in part an extrapolation of the cyclical bounce into a durable, robust recovery,” he said in a July 1 e-mail. “We expect analysts to revise down their estimates in the weeks ahead as the economic data confirm that the cycle bounce has run into significant structural headwinds.”
Wall Street firms overestimated earnings by an average of 13 percentage points in each period between the third quarter of 2007 and the end of 2008 as the first global recession since World War II weakened demand. The S&P 500 dropped the most since the Great Depression in 2008, and $37 trillion was erased from shares globally between October 2007 and March 2009.
Before the April selloff, rising profit estimates helped spur the rally in stocks that began in March 2009. The average forecast for S&P 500 earnings growth in 2010 rose by more than 10 percentage points during the five quarters that ended on June 30, a period in which the S&P 500 gained as much as 53 percent, according to data compiled by Bloomberg.
176% Surge
Forecasts were a better indicator than earnings as analysts foresaw the rebound in income six months before it began. Profit rose 176 percent in the fourth quarter of 2009, ending two years of declines, the longest stretch on record, data compiled by Bloomberg show.
The proportion of S&P 500 companies that raised their profit outlooks reached 8.6 percent during the first-quarter reporting period from April 12 through May 18, compared with 3.4 percent that lowered forecasts, according to data compiled by Bespoke Investment Group LLC. That’s the second-highest level of companies increasing their projections since 2001, data from the Harrison, New York-based research firm show.
The last time the spread was wider was the first quarter of 2004, when earnings began 14 consecutive quarters of growth. The S&P 500 ended that year up 9 percent. This year’s 7.8 percent tumble in the S&P 500 has pushed its price down to 11.7 times projected profit for the next 12 months, the lowest valuation on a year-ahead basis since March 2009, Bloomberg data show.
Revenue, Costs
“Analysts should be revising their earnings estimates a little bit higher because revenues seem to be doing OK and costs seem to be relatively contained.” said Tommy Huie, who oversees about $32 billion as president and chief investment officer of M&I Investment Management in Milwaukee. “We’re medium- to long- term bullish.”
The retreat in stocks is creating bargains before earnings season begins, according to Federated’s Orlando. Estimates rose the most for industries where demand is tied to economic growth such as metal producers, consumer companies and banks, data compiled by Bloomberg show.
“This is either a phenomenal opportunity or the analysts have it wrong,” said John Wilson, chief technical strategist at Morgan Keegan & Co., which manages about $120 billion in Memphis, Tennessee. “In this environment, people should be starting to nibble at some high-quality stocks.”
‘New Citi’
U.S. Steel shares plunged 30 percent in the first half, compared with a 7.6 percent drop in the S&P 500, even as first- quarter profit beat the average analyst estimate by 19 percent. The nation’s second-largest steelmaker by sales posted its smallest loss in more than a year on April 27, helped by higher metal prices. Between March 31 and June 30, analysts tripled their 2010 income estimate to $2.01 a share. In that time, shares of Pittsburgh-based U.S. Steel fell 39 percent to $38.55.
Citigroup, the third-biggest U.S. bank by assets, reported first-quarter profit that more than doubled and the most income for a three-month period since 2007. Chief Executive Officer Vikram Pandit said in February that this year may show the “earnings potential of the new Citi.”
Analysts boosted forecasts for New York-based Citigroup’s 2010 profit eightfold during the second quarter, to 33 cents from 4 cents a share. The shares, which last posted a better annual performance than the S&P 500 in 2006, dropped 7.2 percent in the second quarter. The stock index slid 12 percent.
Macau Casino
Wynn Resorts slid 9.1 percent in June, more than the S&P 500’s 5.4 percent decline, as analysts increased projections by 78 percent. The casino company founded by Steve Wynn posted first-quarter earnings that beat the average estimate by 58 percent as revenue from operations in Macau, China, increased.
While the MSCI World Index of 24 developed countries lost 9.5 percent including dividends in the first half of 2010, bonds gained 4.2 percent, the Bank of America Merrill Lynch Global Broad Market Index shows, reversing the 5.1 percentage point lead stocks had over debt during the same period in 2009.
“There’s more emotion in this market than we’ve ever seen,” Chris Hyzy, the New York-based chief investment officer at U.S. Trust, which oversees about $188 billion, said in a July 2 interview with Margaret Brennan on Bloomberg Television’s “InBusiness.” “As you see this economic recovery take further hold at the end of the summer, you’ll start to see business investment pick up and earnings will drive this market.”
To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net; Lynn Thomasson in New York at lthomasson@bloomberg.net.
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