market perspective-november 2015

Market Perspectives – November 2015

Experience Insight Impact

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Overview: With third quarter earnings season nearly complete, and a marketrally having erased much of late summer correction, valuations once againstand close to relative market highs. In this month’s Market Perspectives, wenot only offer an update on corporate earnings growth, but also scrutinize theexpected earnings growth rate in 2016 and compare it to current marketvaluations. This will serve as a guide for investment strategy.

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What Sort of Earnings Growth Have We Seen?

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• With 3rd quarter earningsreports almost complete, S&P500 earnings declined 4.69%year over year.

• As shown, Energy and Materialssectors have been impacted bysignificantly lower globalcommodity prices, and thiscontinues to negatively impactS&P earnings growth. TheFinancial sector is still battlinglower global interest rates.

• However, Industrials, ConsumerStaples, and Utilities earningshave also turned negative.Instead of a few strugglingsectors, half of the S&P sectorsare experiencing decliningearnings.Source: Bloomberg


How Are Companies Performing Excluding The Energy Sector?

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• This chart shows the overallS&P 500 earnings growthexcluding the Energy sector.Even without the headwinds of$50/bbl oil, the remaining S&P500 companies are still onlygenerating an anemic +2.0%growth rate.

• Slower earnings growth ex-Energy confirms there areother issues at play. Forexample, companies are citingthe strong dollar hurtingexports. Also, manufacturingsectors are fighting againsthigh inventory levels due toslower global demand.

Source: Bloomberg


What Does the Market Expect for the Future?

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• This chart shows both the historical andestimated quarterly earnings growthover a two year period from Q3 2014 toQ3 2016.

• Historical earnings growth is representedon the left of the thin, vertical line andfuture estimates for the next severalquarters are on right of the line. Itimplies that analysts expect a v-shapedrecovery in earnings growth as weprogress into 2016.

• In fact, Q3 2016 S&P earnings areestimated to reach approximately +10%,a strong outlook despite global growthconcerns. It is worth noting that analystsare typically overly optimistic and tendto revise earnings downward as the yearprogresses.

Source: Bloomberg


What Does the Market Expect Excluding Energy?

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• This chart again shows both the historicaland estimated quarterly earnings growth,but here we exclude the Energy sector.

• Analysts’ expectations for higher earningsgrowth in the second half of 2016 are notdriven by stable oil prices. As shown, the Q32016 S&P earnings growth ex-Energy arealso forecasted to grow by 10%. Thus,factors other than oil are expected to pushmarket earnings higher.

• With challenges like a strong dollar andslowing global demand at play, true organicgrowth may prove difficult.

Source: Bloomberg


Where is the Growth Coming From?

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• Analysts’ expectations for double-digit growthrates are primarily driven by the ConsumerDiscretionary and Information Technologysectors.

• Consumer Discretionary earnings are expectedto bounce in 2016 vs. 2015 due to lower energyprices, an improving labor market, rising homeprices, and low inflation.

• A Tech earnings bounce is uncertain. Accordingto JP Morgan, after stripping out Apple andGoogle, overall Tech revenues have been asweak as the Industrials sector.

• Profit margin expansion may be increasinglydifficult. Margins are near all time highs, andlabor markets are tightening.

Note: A large increase is expected in Materialsbut the sector is much smaller relative to othersand its impact is less significant.

Source: JP Morgan

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FY FY

2015E 2016E

Telecom Services 70% 8%

Health Care 17% 19%

Financials 8% 8%

S&P 500 ex-Energy 7% 13%

Consumer Discretionary 7% 14%

Industrials 7% 7%

Information Technology 6% 14%

Utilities 5% 2%

Consumer Staples -1% 7%

S&P 500 -3% 16%

Materials -29% 60%

Energy -91% 364%

EPS Y/Y Growth

S&P 500 Consensus Sector Growth Estimates


What Are These Companies Saying?

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• Corporate outlooks during this earnings seasondon’t necessarily support a rapid earningsrecovery.

• This chart aggregates changes in companies’earnings outlooks compared to analysts’estimates. For example, if a management teamissues quarterly guidance higher than theconsensus estimates, it’s included in the“Revised Up” row.

• S&P 500 companies have issued far moreneutral and declining estimates for this quarterand Q1 earnings than positive revisions.

• We would expect Consumer and Tech companyoutlooks to be more positive, however theyhave been just as neutral and negative as thebroad market. These earnings revisions appearinconsistent with the growth leadershipexpected for these sectors.

Source: Bloomberg.

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Q4/15 Q1/16 2016 % of Total

Revised Up 13 4 8 13%

Revised Down 57 25 12 48%

Neutral 35 24 17 39%

Total: 105 53 37 100%



Neutral 23 8 4 37%

Total: 61 27 7 100%



Neutral 53 29 2 42%

Total: 126 66 10 100%

Total # of U.S. Companies Issuing Earnings Outlooks

Comparison of New Forecasts vs. Consensus Estimates

`------------U.S. Technology------------

`------------U.S. Consumer Discretionary------------

`------------S&P 500------------


P/E Multiples Are High Relative to Uncertain Expectations

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• The green line represents thetrailing 12 month S&P 500 P/Emultiple over the last five years.As illustrated, multiples havebeen expanding for almost fiveyears, and at 18.6x today, theyare only slightly below the fiveyear peak of 18.9x hit this pastJune.

• The purple line shows the S&Pforward earnings. Contrary tovaluation multiples, they havestagnated and declined slightlyover the past two years.

• It appears multiples have movedfar ahead of earnings. Investorsare depending on a v-shapedrecovery in earnings growth.

Source: Bloomberg

Conclusion


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Conclusion: The trend of rising earnings multiples continues despite concernsthat lower global demand is beginning to impact a broader segment of thedomestic economy. While questions remain as to whether or not slower ornegative growth in some sectors of the economy will spread, based on currentstock prices and valuations, market participants do not appear to beconcerned. We believe a more diversified portfolio with some measures ofdownside protection remains appropriate.

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Opinions expressed in this commentary may change as conditions warrant and is forinformational purposes only. Information contained herein is not intended to be personalinvestment advice for any specific person for any particular purpose. We utilize informationsources that we believe to be reliable but cannot guarantee the accuracy of those sources.Past performance is no guarantee of future performance; investing involves risk and mayresult in loss of capital. Consider seeking advice from a professional before implementingany investing strategy.


Disclaimer

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market perspective-november 2015

Economy & Finance