With companies holding their annual investor days throughout December, the earnings estimates will start to take shape for full-year 2016, as analysts update their models using both their own inputs and what they are hearing from management.
This coming week, Home Depot (N:HD) and United Technologies (N:UTX) hold their annual Investor / Analyst days, while Costco (O:COST) reports their fiscal Q1 ’16 and Toll Brothers (N:TOL) (probably the safest balance sheet in the homebuilder sector) reports their fiscal Q4 ’15 and hopefully gives guidance for fiscal ’16. Lennar (N:LEN) reports their Q4 ’15 the week of December 18th, 2015. (Long all names in various sizes for clients: the largest position probably being UTX.)
The point being that analysts are constantly updating their inputs and models for the coming twelve months, but the next few months are critically important since managements are giving the street their best guess at 2016 guidance. While there has been a lot of commentary about subdued expectations for 2016 from the likes of Brian Belski, Goldman Sachs) and so many other prognosticators, the fact is that – at least in terms of S&P 500 earnings – we should expect another “mid-to-high-single digit earnings growth” year.
Thus the question becomes, “Do we see P/E expansion or contraction in 2016” ? With a current P/E of 17(x), and the bottom-up estimate expecting 9% EPS growth next year for the S&P 500, hence if the S&P 500 JUST returns the earnings growth in 2016, without any P/E expansion, we should see a better year in ’16 in terms of S&P 500 expected return than a lot of prognosticators are expecting.
The trend in Financial and Energy Sector Estimates: (The first column is the week ended, the 2nd column is the expected growth rate for the Financial sector, the third column is the expected growth for the Energy sector):
- 6/26/15: +10%, +35%
- 9/25/15: +9.6%, +10%
- 10/2/15: +9.5%, +9.2%
- 10/9/15: +9.3%, +7.6%
- 10/16/15: +8.6%, +5.3 (3rd Q earnings season began this week)
- 10/23/15: +8.3%, +2.7%
- 10/30/15: +8.1%, +2.6%
- 11/6/15: +8.1%, +0.6%
- 11/13/15: +8.2%, +0.9%
- 11/20/15: +8.5%, +0.9%
- 11/27/15: +8.5%, -0.6%
- 12/4/15: +8.6%, -0.5%
Analysis / conclusion: As we use this site to look at various sectors over the next few days and weeks, the reason I chose to start with Energy and Financials is to show the difference between a stable sector and sector that continues under pressure, but that might be in the process of bottoming.
Let’s start with the Energy sector: readers can see how over the summer, the 2016 earnings growth for the sector continued to deteriorate. My question is how much additional pain did China cause in terms of China’s slowing growth potentially slowing demand, and how much of the issue is OPEC supply, or some combination of both. Both Exxon (N:XOM) and Chevron (N:CVX) rallied on above average volume on Friday, December 4th, despite OPEC raising the production ceiling to 31.5 million barrels per day. The other aspect to Energy is that with Draghi’s testimony on Thursday morning, it sure left the market with the impression that Europe is making small improvements, and is certainly not getting worse.
If Europe and Japan are improving if only slightly, and if China can remain stable, and the US continues on its slow glide path higher, could a bottom be called for the Energy sector?
The Energy Select Sector SPDR (N:XLE) and the iShares US Energy (N:IYE) were bought for clients in early October within many accounts, but Energy is still under-weighted (for the most part). Technically the XLE and the IYE put in a “double-bottom” in late August, early September ’15 on the charts. At that point the XLE and the IYE were as oversold as in late ’08, early ’09. Energy might be the biggest surprise sector of 2016, but I want to see how 2016 estimates fall out in the next 4 weeks.
The Financial sector is the definition of “low-risk, higher reward” today, if only from a credit perspective. Banks today are probably as clean as they have ever been from a credit risk perspective, as the “colon blow” of the 2008 and 2009 and the regulatory frenzy that followed has left the banks with more capital, lower-risk businesses, and less business risk than at any point in the last 30 years. Even though most major financial institutions need Treasury “permission” to pay dividends and repurchase stock today, the Financial sector should perform no worse than in-line with the S&P 500 and offer some alpha as the US economy returns to normal.
The rally in Financial’s after the November payroll report on Friday, December 4th was somewhat misguided in my opinion. What Financial’s need for a sustained rally is a “steepening yield-curve” trade, much like 2013. The Taper Tantrum that started in the Spring of 2013, saw a move in the 10-year Treasury yield to 3% by the end of the year. Just the Fed hiking rates wont do it – in fact an inverted or flat yield curve might be worse for the Financial sector today, given that banks are doing less trading and less “non-spread” revenue generation than in the last 20 years.
For Financials to work, that 10-Year Treasury yield must continue to work towards 3%, or the late 2013 high tick.
Along with Technology, Financials remain one of the largest sector overweight’s for clients and that has been the case for a few years. Chicago Merc (O:CME) and Schwab (N:SCHW) are two financials that should outperform with an active FOMC, yield curve volatility, and higher short-term interest rates.