In Greek mythology, Icarus failed in his attempt to escape the
island of Crete because he succumbed to hubris and didn't heed his
Icarus' father repeatedly warned that the wings he had built
were made of only wax and feathers and would melt if Icarus
attempted to fly too close to the sun with them.
The story ends with Icarus falling to his death. Icarus
got caught up in the euphoria of flying and made the mistake
of becoming overly ambitious in his escape.
Perhaps we too should take a step back from our giddiness when
it comes to 2013 earnings that may also still be flying too
Bottoms Up Earnings
Earnings season for 4Q 2012 is in full swing with 78% of
constituents reporting and a few of the larger retail ones still
On 2/27 Target (
) reports and on 2/21 is Hewlett Packard (
) and Wal-Mart (
). March wraps up with some more large retailers like Costco
) and Staples (NASDAQGS:SPLS).
The Top Down Earnings
2012's S&P 500 (NYSEARCA:SPY) reported earnings are expected
to reach a new all time high at $88/share. For comparison,
2011's reported earnings were $87/share and 2Q 2007 trailing (the
previous stock market peak) was $85/share.
By the end of 2013, analysts are expecting earnings to grow 15%
to another all time high of a reported $101/share. Below are
the latest S&P earnings for the past year and next year's
reported estimates in columns 1 and 2, annual growth rates in
column 3, and a comparison of today's estimates with the ones that
were estimated back in October in columns 4-6 (when I wrote another
article on the lofty earnings found
). Since then earnings estimates have come down, but is it
It seems analysts and companies are all expecting continued
earnings growth into next year as the above S&P data
supports. But very few seem to be concerned that earnings
growth continues to be ratcheted down and pushed out as the latest
headline from Forbes identifies, but doesn't comment on, "S&P
500 Revenue and EPS Estimates Ratchet Down After January
After the dust has settled, full year 2012 earnings barely grew
at all (estimated now to be only 1.2% over 2011), but 2013 full
year earnings are still expected to grow even more than 2011's
impressive 12.4%. Even more, margins are now starting to fall
for the first time since 2009 (more on that below).
All four of the latest earnings quarters have been clawed back,
some significantly, yet 4Q 2013 remains unscathed and elevated as
companies are unwilling (so far) to come off of full year guidance,
adding up to a 15% year over year growth.
On Oct.9, 2012 with the S&P at 1450 we first
identified earnings estimates as being too lofty.
Those estimates indeed have fallen and we were able to take
advantage of the market's technical decline into November in our
Technical Forecast published Oct.10, "If price continues to fall
from its high today below both the medium term uptrend channel that
connects July, Sept, and now Oct lows as well as 1450, then shorts
can be opened up with the assumption that 1430 will be visited
again." 1430 was indeed visited again, as was 1374, where we
took short profits.
What's that you Say about Margins?
Like Icarus, analysts it seems are assuming earnings can go
up forever into perpetuity. But in reality, S&P earnings
(NYSEARCA:SPY) are cyclical and are now starting to slow.
They rise and fall over time based on normal macro
There is easy justification for this cyclicality. When
earnings rise, so do margins. When margins rise, competition
steps in as barriers to entry are able to be overcome.
Competition then puts pressure on pricing. This lowers
margins and eventually earnings. If there is any doubt to
this economic fact, just research the Android (NASDAQGS:GOOG)
versus Apple (NASDAQGS:AAPL) situation unfolding.
Margin Peaks - A Few Examples
Operating earnings margins peaked in the June 2012 quarter at
9.2%, where they also were in the Dec 2011 and Mar 2012
quarters. Now, margins have also started to decline down to
only 9.0% in the Sept 2012 quarter. It remains to be seen,
but it wouldn't be surprising given the recent earnings cuts that
the Dec 2012 quarter will be below 9.0%, setting up a trend of now
The same thing happened in 2007 near the previous market peak
(NYSEARCA:IVV). Margins hit 9.0% in the Sept 2006 quarter and
remained topped out between that level and 9.3% for the next
year. Then in the Sept 2007 quarter margins declined to 8.9%
and kept falling from there.
The below chart, from Deutsche Bank, outlines the historical
cyclical nature of margins. Earnings margins have risen and
fallen throughout history, they have hardly been linear, and this
is perfectly normal.
I am not one to assume "this time it's different" and am very
cautious that earnings and margins at these elevated levels are not
sustainable. We have already started to see the cracks
forming in earnings, with only 1.2% expected growth over 2011 as
well as the first decline in margin rates since 2009.
A continued deterioration of margins would certainly bring down
full year 2013 estimates.
Icarus Flew Too High, Earnings Too
Given the market is at 30 year margin highs (matched only at the
peak in 2007), competitors are currently stepping in, lowering
prices, pressuring margins, and resulting in lower earnings
estimates. (See Apple)
Looking at the above chart, not only do we see the cyclicality
of earnings margins but we also see that margins are higher than
they have ever been since the early 80's when the data
begins. Margins at over 8% are a reason to be earnings
cautious, earnings over 9%, those are left for Icarus.
Aside from the cyclicality of margins, the upcoming issue of
Profit Strategy Newsletter
highlights nine other 2013 mega investment themes along
with tradable ETFs to take advantage of the long term market
trends. Also published is the Technical Forecast which looks
to take advantage of the shorter term market trends across multiple
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