The market is feeling good again, hoping that the feared
tapering decision from the Fed may not be so imminent after all.
May be the market is correct in interpreting recent data,
particularly the outsized revision to the first quarter's GDP
growth numbers on Wednesday. But I don't see it this way, as I
continue to believe that the economy has enough momentum on its
own to let the Fed to take its foot off the QE paddle.
Wednesday's GDP revision was a disappointment, but that's
essentially ancient history and has little relevance to what is
happening at present and what could be expected in the coming
quarters. This morning's in-line Jobless Claims and strong
Personal Income & Spending report provide further
confirmation that growth in the second quarter is on a better
trajectory than was expected just a few weeks back. We will know
more next week as the June non-farm payroll and ISM data comes
through, but a steady stream of recent economic readings have
been showing that budget sequester and tax rate changes from
earlier this year have had a less dampening effect than earlier
feared. The market's inability or unwillingness to read the Fed
correctly is the source of all volatility in the market at
present and the issue will likely not go away any time soon.
The Fed watch promises to be the dominant theme this summer, but
the start of the Q2 earnings in a few days could potentially
spotlight a key vulnerability for the market. Expectations
remains low for earnings growth in Q2, with total earnings for
companies in the S&P 500 expected to be down -0.3% from the
same period last year, on -0.5% lower revenues and essentially
flat margins. This is sharp drop form the roughly +4% Q2 earnings
growth expected in early April. The growth picture becomes even
more underwhelming when Finance is excluded from the tally -
Finance is expected to have another strong quarter.
Low expectations mean an easy enough hurdle rate for companies to
jump through. But we have become accustomed to roughly two-thirds
of the companies beating earnings expectations anyway. It will be
interesting to see how top-line surprises come through in Q2,
particularly after the unusually weak revenue results in Q1.
Guidance is always important, but it has assumed even more
significance this time around given the elevated expectations for
the second half of the year and next year. Earnings growth was
less than +1.5% in the first half of 2013, but is expected to
ramp up to +9.5% in the second half.
Importantly, the growth expectations for the second half of the
year are not due to easy comparisons - the level of total
earnings in the 2013 Q3 and Q4 each represent new all-time high
records. My sense is that estimates need to come down in a big
way. The market hasn't cared much in the recent past about
negative revisions as estimates have come down as aggregate
earnings estimates have been coming down for over a year now. But
if we are entering a post-QE world, as I believe we are, then it
would be difficult to overlook negative earnings estimate
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