Amid the depressing reality of Washington's partisan intransigence, investors are advised to remember that 3Q13 earnings season is not subject to government shutdown. Many investors regard the third-quarter reporting period as the most crucial of the four reporting periods, because it has one foot in the current year and one foot in next year.
By the time companies report their calendar third quarter, usually in late October through early November, nine calendar months of corporate performance are available for inspection. Companies either have or have not attained the goals they set back in January - or that the investing public set for them. Simultaneously, by late in October companies are already looking ahead into the coming calendar year. The guidance provided for 4Q, notwithstanding its seasonal strength, shines a light on the calendar year ahead.
We took a look at the annual rate of change in third-quarter earnings going back to 1990. Our proxy is S&P 500 earnings from continuing operations. While most of the data reflects Standard & Poor's own estimates, beginning in 2012 we use S&P 500 earnings from continuing operations data as compiled by Bloomberg. Since 1990, third-quarter earnings from continuing operations have averaged 7.1% appreciation. If we take a narrower slice of the pie, dating back to 2000, earnings have averaged 5.0% appreciation in the third quarter.
Of course there are significant currents beneath that placid upper-single-digit gain. There were the "collapse" years of 2001 and 2008, when 3Q earnings plunged 35% and 24% respectively. Coming out of any recession, there are also boom years such as 2003 and 2010, when earnings jumped 27% and 18% respectively.
The 3Q earnings pattern in the years bracketing the current bull market is defined by the abrupt nature of the downturn in autumn 2008. Many purchasing managers and CFOs recall September 2008 as a time when demand dropped suddenly as though someone had flipped a switch. Thus in the recovery year of 2009, 3Q earnings were down 1% against a still-tough 3Q08 comparison.
After the "catch-up" year of 2010, with its 18% gain, 3Q earnings growth has been tepid: 0.6% in 2011, and 4.5% in 2012. Altogether, 3Q EPS growth across the 2009-12 period has averaged 5.5%; and if 2008 is included, the average swings to negative (-0.4%). That is in sharp contrast to the 2002-06 timeframe, when 3Q EPS growth averaged 20.4%.
In this quarter that we have called out as most vital to investor confidence, the weak recent earnings pattern is being reflected in equity performance. Our survey period is the "pure" earnings period of October 15 through November 15; including the two weeks before and after that period risks bringing extraneous events (such as federal fiscal year-end) into the equity performance calculus.
From 1990 through 2012, the S&P 500 averaged 7.1% appreciation in the 10/15 through 11/15 period. But that includes the mega-bull years of the mid- through late-1990s. From 2000 through 2012, the S&P 500 averaged meager appreciation of 0.4% across the mid-October to mid-November time frame. And from 2009 through 2012, the S&P 500 averaged a decline of -0.5% from mid-October to mid-November. If 2008 is included, the 3Q reporting "intra-month" has averaged a 1.9% decline.
Bull-market skeptics review this data and respond "of course." We have pointed out a strong correlation between overall EPS growth and overall market appreciation from spring 2008 to the present; it makes sense that this correlation would exist in specific measurement periods.
Bull-market proponents will see the weak market performance across the reporting period inter-month and also say "of course." Seasonal patterns in the economy and stocks support the view that summer is an economically soft period. Third-quarter results - which encompass summer-month performance - capture that weakness and churn it back into the stock market. Most stock market years end with a strong second half of November and a very strong December.
This lens on the past helps frame expectations for the current earnings period. Argus expects 4.6% growth in 3Q13 S&P 500 EPS from continuing operations. We then look for a "big finish" 4Q13 with 9.1% EPS growth, capping full-year EPS growth of 4.9% and full-year continuing-operations EPS of $111.00. The bottom-up analyst data compiled by Bloomberg anticipates 2.7% EPS growth in 3Q13, but an even bigger (9.6%) finish in 4Q13; that would support 4.5% growth for 2013, to $110.67.
For 2014, we look for 9.5% growth to $121.50. We are not alone in anticipating a doubling in EPS growth relative to 2013; the Bloomberg bottom-up analyst consensus assumes 9.7% growth in 2014 continuing-operations EPS, to $121.41.
You may fairly ask, how come? We expect the gradually positive signs emanating from Europe to stabilize the economy and coalesce into the beginnings of recovery and growth in Europe next year. China is beginning to accelerate; the HSBC purchasing managers' index for China reached a six-month high in September. And the U.S. consumer economy remains in fairly good shape. Automotive new unit sales are running at a 16 million SAAR.
On the housing front, the Case-Schiller 20-City Home Price index recently rose the most in seven years. Rising home values are increasing the equity in everyone's home, encouraging some formerly "underwater" buyers to put their homes on the market. The resultant rise in homes-for-sale inventory threatens to slow the double-digit gains in home prices; but rising inventories are also pulling more potential home buyers into the mix.
Third-quarter EPS season this year will be shadowed by the contentious battle over the federal budget and debt ceiling. The budget must be approved by October 1, although contingencies such as spending-authority extensions could be utilized. The debt-ceiling deadline, which is also subject to wiggle-room remedies, is in mid-October. Normally, we would regard the debt-ceiling imbroglio as lots of sound and fury signifying nothing; the debt-ceiling is always ultimately raised.
The GOP, still stinging from its election-night defeat, wants to defund Obamacare, which has tepid proponents and rabid opponents. The GOP itself is divided, given the risks that an unpopular shutdown could weaken the Republican majority in the House at the coming mid-term elections. But feelings run so high on Obamacare that we have not ruled out a shutdown - and neither has the market.
Third-quarter earnings will be further shadowed by more to-and-fro on QE and Fed policy. Altogether, we expect third-quarter 2013 earnings - even from the back of the stage - to convey a corporate earnings environment that is uneven, but net positive.