Fed Bridges Gap to Earnings Pickup in Modest U.S. Growth
Company financial reports are showing little improvement in demand. The Federal Reserve’s third round of stimulus could boost prospects for faster sales gains in the second half of this year.
With modest economic growth weighing on results, revenue for companies in the Standard & Poor’s 500 Index has missed the aggregate analysts’ estimate by about 0.7 percent, according to data compiled by Bloomberg, even though earnings have been better than projected. Through yesterday, 452 of the benchmark-index members have reported for quarters ending between Feb. 16 and May 15.
Amid “a languor” that’s set in about the U.S. expansion, the Fed’s bond-buying program is “bridging the gap to a better operating environment,” said John Manley, chief equity strategist for Wells Fargo Funds Management, which advises on $221.2 billion in assets in the Wells Fargo Advantage Funds. The Fed is purchasing $85 billion of Treasury and mortgage debt a month, in its third round of quantitative easing.
The central bank “won’t stop pumping money into the economy until it’s clearly doing better,” which helps explain investor optimism for second-half corporate revenue, Manley said. Meanwhile, companies “haven’t run out of rabbits in a hat” to cut costs, so there’s the potential for earnings leverage if sales improve because companies have done a good job of reducing excess spending, he said.
Investors have brushed off the recent company reports to push the S&P 500 up 4.1 percent since April 8. They’re encouraged by signs that demand hasn’t weakened further and the moderate expansion hasn’t derailed earnings.
Caterpillar Inc. (CAT) has outpaced the S&P 500 by about 7 percentage points since April 19, the trading day before the Peoria, Illinois-based company reported first-quarter results that missed consensus analyst estimates and cut its 2013 forecast.
“Without a doubt it was a challenging” period, Corporate Controller Michael DeWalt said on an April 22 conference call. “We lowered production schedules, we’ve had rolling plant shutdowns at a number of facilities during the fourth quarter and continued that in many facilities in the first quarter.”
The 5.2 percent aggregate earnings surprise was achieved largely by tight cost controls, said Leo Grohowski, chief investment officer of New York-based BNY Mellon Wealth Management, which oversees $188 billion. Concerns about the “anemic economy” have caused business leaders to be very cautious about increasing inventory, hiring employees or undertaking capital-spending projects, he said.
Gross domestic product expanded at a 2.5 percent annualized rate in the three months ended March 31, following a 0.4 percent gain in the fourth quarter, according to the Commerce Department. Growth was slower than the 3 percent median estimate of economists surveyed by Bloomberg.
“There’s been a good deal of skepticism out there,” and recent corporate earnings emphasize that “things aren’t great right now,” Grohowski said. What’s more important to investors is the prospect for a second-half acceleration, in which “a great deal of pent-up demand is unlocked,” fostering higher revenue and faster earnings growth, he said.
The U.S. economy will expand 2.2 percent in the third quarter and 2.6 percent in the fourth, according to a Bloomberg survey of 73 economists from May 3 to May 8.
The first quarter largely was one of “delayed gratification,” as many businesses that are most sensitive to economic improvement didn’t materially change their full-year guidance, said Ron Sloan, who oversees about $12 billion as chief investment officer of Atlanta-based Invesco Ltd. (IVZ)’s U.S. core equity team. Sales-estimate misses also “weren’t that significant for the most part,” so “it’s too early to give up on the year for cyclical stocks.”
Shares of industrial companies have held up decently amid a “punk earnings environment’ that’s been ‘‘uniformly disappointing,” Sloan said.
Parker Hannifin Corp. (PH), a maker of pumps, valves and other products, continues to “perform very well despite a challenging global-growth environment,” Chief Executive Officer Donald Washkewicz said on an April 25 conference call. Even after North American orders for the Cleveland-based company fell 10 percent in the three months ended March 31, they appear to be “bouncing off the bottom.”
Parker Hannifin’s stock has risen 4 percent since April 24, the day before it announced fiscal third-quarter net sales of $3.31 billion, missing the consensus analyst estimate of $3.35 billion. That compares with a 3 percent gain in the S&P 500.
There are about seven months left in the fiscal year for many S&P 500 members, giving them time to recoup lackluster results, Sloan said.
Even so, “there’s still a great deal of uncertainty out there,” including a “lingering fear of a spring or summer slowdown,” Grohowski said. “Companies are playing it close to the vest.”
While investors may be optimistic about the second half of the year, “there’s no evidence that growth is accelerating,” said Barry Knapp, head of U.S. equity strategy in New York at Barclays Plc. Earnings for the members of the S&P 500 are projected to rise 7.2 percent this year amid sales gains of only 2.5 percent, he said, citing figures compiled by Barclays.
Full-year profit forecasts already have come down from as high as 10 percent, Knapp said. Barring a faster economic pace that would boost sales, “it looks like earnings-growth estimates will get cut further.”
There have been “some hopeful signs” among a mixed bag of economic indicators, Sloan said. Employers added 165,000 workers in April, more than the 140,000 forecast in a Bloomberg survey of economists, Labor Department data show. The U.S. trade deficit narrowed 11 percent in March to $38.8 billion from a revised $43.6 billion in February, the second-lowest level in three years, according to the Commerce Department.
Corporate sales probably will improve before the Fed halts its Treasury-buying program, Manley said. The central bank’s goal of sparking a “classic chain reaction” is showing traction in the equity market, while indications from companies “that nothing has changed” support the bull case that revenue growth could improve later this year, he said.
In the meantime, companies have shown discipline managing expenses as soon as they hit a soft spot, Sloan said. To make up for missing sales estimates and keep margins alive, many were “rolling into a ball to survive,” like “when a possum sees a wolf.” Recently, executives are expressing more optimism, which encourages investors.
“Some companies are starting to unwind from the fetal tuck position,” Sloan said.
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