S&P 500 Buy Ratings at High as Valuations Offset Profit

S&P 500 Buy Ratings at High as Valuations Offset Profit Drop
A Pratt & Whitney PurePower PW1000G engine. Photographer: Simon Dawson/Bloomberg

The same securities analysts warning of the first decline in quarterly earnings since 2009 are also more bullish than ever on U.S. stocks.

A total of 247 companies in the Standard & Poor’s 500 Index have more buy ratings than sells and holds, a record in Bloomberg data starting in 2000. Bullish recommendations have been expanding even as Wall Street firms cut their forecast for second-quarter net income in the U.S. to a decrease of 1.8 percent from a gain of 2 percent in April, more than 10,000 estimates compiled by Bloomberg show. Earnings season began today with a report from Alcoa Inc.

Bears say rising equity volatility, declining profits and the approaching U.S. presidential election mean the 4.5 percent drop in the S&P 500 since April will continue. Bulls say analysts are advising clients to buy because earnings are still on track to reach a record this year and the index is trading 16 percent below its average valuation since the 1950s.

“My picks aren’t based on one quarter,” Howard Rubel, a New York-based equity analyst at Jefferies & Co., said in a July 5 phone interview. “It’s not always captured in a headline how many pieces of judgment one needs to incorporate into a stock recommendation, and a quarterly earnings report is only one item. You have to look at things over a period of time.”

Analyst Recommendations

Rubel, ranked by Bloomberg among the top five analysts in more than half the companies he covers, lowered his profit estimate for United Technologies Corp. last month while maintaining a buy rating for the maker of Pratt & Whitney jet engines. The Hartford, Connecticut-based company has 21 analysts recommending clients purchase the shares, compared with four holds and no sells, data compiled by Bloomberg show. Since October, analysts have cut estimates for profit this year by 9.6 percent to $5.49 a share.

The last time earnings and share ratings diverged was the third quarter of 2009, when the S&P 500 was six months into a rally that lifted it more than 100 percent through April 2012. Analysts predicted a 23 percent drop in S&P 500 annual profit, while 205 companies in the index had more buy ratings than sells and holds. The June-to-August period that year was the index’s last quarter of negative earnings growth.

Yair Reiner, a New York-based analyst at Oppenheimer & Co. raised his rating on Boeing Co., the world’s largest maker of cargo aircraft, to outperform from market perform on June 24, while lowering his earnings forecast by 7 cents to $1.04 a share for the second quarter. The stock is up 2.4 percent since he increased his recommendation that day, beating the S&P 500.

Boeing Estimates

“Progress on production gave me a much higher level of confidence in my year estimates and the company,” Reiner said in a July 3 phone interview. “If they can provide incrementally good news on the profit front, investors should be more than willing to overlook blips in any one quarter.”

Boeing delivered 150 aircraft in the three months through June, positioning itself to meet a 2012 target, according to a statement last week. Profit next year is forecast to rise 23 percent, followed by a 16 percent increase in 2014, data compiled by Bloomberg show. The Chicago-based company has 28 analysts telling clients to buy the shares versus three holds and one sell and may report that second-quarter earnings fell 12 percent to $1.10 a share, analyst projections show.

Alcoa, the largest U.S. aluminum producer, reported second-quarter earnings and revenue that beat analysts’ estimates after an increase in orders from the auto and aerospace industries. The New York-based company was the first in the Dow Jones Industrial Average to release results. The S&P 500 fell 0.6 percent to 1,354.68 last week, after the biggest June rally since 1999. It declined 0.2 percent to 1,352.46 today.

Recession Forecasts

Analysts are too bullish amid forecasts for a recession in Europe and unemployment in the U.S. that has exceeded 8 percent since February 2009, according to Wayne Lin at Legg Mason Inc.

S&P 500 companies have a total of 5,898 buy ratings, 9.4 times the number of sells, data compiled by Bloomberg show. A year ago, there were 8.4 buys for each sell. Total buy ratings for the S&P 500 have outnumbered sells by a factor of 9 since 2000, data compiled by Bloomberg show. Less than half the time, there have been more total buys than sells and holds.

“My expectation is that we are going to start to see that weakness flow through to corporate earnings,” Lin, a money manager at Baltimore-based Legg Mason, said in a July 3 phone interview. His firm oversees $627 billion. “There’s a risk to just jumping in just because stocks are cheap. They may be cheaper later.”

Presidential Vote

The U.S. equity benchmark has gained an average of 0.1 percent in third quarters before a presidential vote since 1945, the worst return of the year and down from an average increase of 2.2 percent between April and June, according to S&P.

This quarter is the first since 2009 that analysts project earnings in the U.S. equity gauge will contract after Europe’s debt crisis and slowing growth in China reduced overseas demand, data compiled by Bloomberg show. U.S. employers increased payrolls by 80,000 workers last month and the unemployment rate held at 8.2 percent, the Labor Department reported on July 6.

“The question will be, we know you had a soft quarter, how does the rest of your year look?” Michael Vogelzang, who oversees more than $2 billion as president and chief investment officer at Boston Advisors LLC, said in a July 3 phone interview. “We’ve seen disappointing earnings and stocks move up, because they’ve been discounted. I think we are there.”

Profit Growth

Profit growth for S&P 500 companies is forecast to resume in the second half of the year, boosting annual income to a record $107.05 a share. Since the end of 2009, the index’s median quarterly earnings growth has been 25 percent, data compiled by Bloomberg show. Freeport-McMoRan Copper & Gold Inc., the world’s largest publicly traded copper producer, may say profit shrank 40 percent during the second quarter, based on analysts’ estimates compiled by Bloomberg. That would be the first drop since 2009 for the April-to-June period. The Phoenix-based company has 22 buy ratings versus three holds and no holds.

The economy in China, the world’s biggest consumer of copper, has slowed for the past five quarters and prices of the metal are down 21 percent during the past 12 months. Last week, the People’s Bank of China cut its key interest rate for the second time in a month and allowed banks to offer bigger discounts on their own lending costs.

Broadcom, Mattel

More than 35 analysts recommend buying Broadcom Corp. even as estimates show the maker of chips that help mobile devices connect to the Internet will have a 6.9 percent drop in earnings when it reports July 24. While that will be the first second-quarter drop since 2009 and profits will also fall in the July-to-September period, the fourth quarter will see a 23 percent increase, according to projections. Nine analysts have hold or sell ratings.

Time Warner Inc., owner of Warner Bros. studios, has more than twice as many buy ratings as it does sells and holds, while analysts project second-quarter net income will slump 9 percent. Mattel Inc., the world’s largest toymaker, will report a 23 percent decline on July 17, yet more analysts recommend owning the company than selling it.

Equity valuations are cheap enough to account for weaker profit growth, said Tim Holland of Tamro Capital Partners. The S&P 500 trades at 13.7 times reported earnings, 16 percent below the average since 1954, data compiled by Bloomberg show. Should companies meet annual profit projections, the index would be trading at a 21 percent discount to the historic mean.

“It’s not the start of a downward trend,” Holland, portfolio manager at Tamro, which oversees $1.75 billion said in a telephone interview from Alexandria, Virginia. “U.S. equities are attractive, the economy seems to be in very good shape relative to other markets. We are very constructive on U.S. stocks.”

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