Even amid the first sizable stock correction since last autumn, the earnings season is playing out as expected, with good growth visible against an easy year-ago comparison (we caution that it is very early in the season). Economic data for the final months of 2013 is coming in near or slightly below consensus expectations; note owever that the economic consensus has set a very high bar for most data points. Economic expansion and earnings growth are both vital to keeping equity valuations within an attractive range, and so far both are behaving as anticipated.
Earnings: Okay so far
The calendar 4Q13 earnings season has featured some high-profile softness, most notably from big tech (Intel (NASDAQ:INTC), IBM (NYSE:IBM) and Apple (NASDAQ:AAPL)). But so far, the season overall has been predictably positive and slightly above expectations. As of 1/27/14 in the calendar 4Q13 EPS season, 129 of the S&P 500 component companies had reported. One hundred and three companies, or 80% of S&P companies reporting to date, posted positive year over year EPS comparisons, 21 reported earnings that were lower than the year-earlier level, and five reported unchanged results. Average annual EPS growth for companies reporting to date has been 12.7%. We are not surprised at the high percentage posting positive annual comparisons, given the easy comparison against a year-earlier period impacted by fiscal cliff and Superstorm Sandy - and companies' tendency to under-guide.
Of slightly more concern is the number of unfavorable EPS surprises. As noted, comparisons for 4Q13 are easy against a 4Q12 period impacted by the fractious presidential election, the pending fiscal cliff, and Superstorm Sandy after-effects. For those companies in the S&P 500 that had reported as of 1/27/14, 67% reported positive EPS surprises while 21% reported negative surprises (12% reported as-expected results). That two-to-one majority of positive over negative surprises for 4Q13 looks good - until you compare it with the year-earlier quarter. For the entire 4Q12 reporting season, 69% of reporting companies reported positive surprises, 10% were right on the money, and 21% reported negative surprises.
Have analysts suffered a sudden decline in forecasting ability? We'd say that analysts, like the broad investing public, may now be taking too bullish a view of prospects for their covered companies, and that a year ago, they were too bearish.
U.S. Economic Data: Just missing, but the bar set high
Economists too seem to be in an ebullient mood. We took a look at economic data reported in the middle weeks of January and since the surprisingly weak December non-farm payrolls report. Generally, the data have supported the view of an expanding economy, while sometimes missing consensus forecasts. This was particularly noticeable in the vehicle sales data reported early in the month and the housing data reported at mid-month.
On the other hand, some data has surpassed expectations. December retail sales were solid, rising 0.2% overall (vs. the 0.1% consensus call) and 0.7% excluding vehicle sales (vs. the 0.4% consensus). Cold weather prompted consumers to catch outerwear and apparel sales. Cold snowy weather, needed to prompt outerwear sales, may keep consumers out of the mall but no longer keeps shoppers from buying. Amazon (NASDAQ:AMZN) and the other e-tailers had another record holiday season.
Steady month over month gains such as those noted above have built a very strong annual comparison. Core retail sales, which back out vehicles, gasoline and building materials, rose at a nearly 7% rate over the past 12 months. The Fed looks at core retail sales when determining policy. This data point will likely reaffirm the current pace of Fed tapering, which calls for cutting monthly bond buying in additional $10 billion increments on a regular six-week schedule.
The Fed need not worry about inflation, at least at present. In December, producer prices edged higher. But 2013 represented the most subdued annual rise in wholesale prices in five years. For calendar 2013, producer prices inched up just 1.2%, the lowest level since the Great Recession year of 2008. Aided by weak commodity prices and declining energy prices, corporations are reaping gross margin benefits from low input prices. In 2008, economic activity was moribund. In 2014, low input costs are offsetting what would normally be inefficiencies as corporations race to meet demand within an expanding economy.
Amid surging consumer demand and without the overhang of higher input cost, U.S. Industrial production in December advanced 0.3%. The December gain, along with strength in November (up 1.0%) and October, made 4Q13 the strongest industrial quarter since 2010. Capacity utilization edged up to 79.2% in December. Housing starts for December were an example of strong data that missed a too-aggressive consensus call - starts in the month fell 9.8%. But for 2013 overall, builders started 923,400 homes, up 18.3% from 2012 and the highest level since 1.34 million units in 2007.
Among data points that exceeded expectations, initial unemployment claims and continuing claims have both been lower than the economists' consensus. Among data points that missed expectations, University of Michigan/Reuters consumer sentiment slid to 80.4 in January from 82.5 in December. We believe the weak December non-farm payrolls number may have weighed on the sentiment index.
With January more than half-complete, the S&P 500 has suffered its first sizable selloff since November 2013. Normally one month's performance does not matter much in the investing scheme of things. But investors fret and worry over "the January predictor." By our measure, the January predictor is only half-right, and we'll explain why.
Since 1980, January has been up 22 times on the S&P 500. Nineteen of those times, a rising January accurately "predicted" that the market would advance for the year. Three of those times, January rose but the market went down. That means that since 1980, rising Januarys have predicted a rising market 86.4% of the time. Pretty accurate.
Also since 1980, January has been down 12 times on the S&P 500. But the market has not taken this guidance very well. Five times when January was down, the S&P 500 was down for the full year. But seven times when January was down, the S&P 500 registered a positive performance for the year. Pretty inaccurate.
There is a potential overhang on stocks this year related to the mid-term election cycle. Mid-term elections can be more ideologically driven than presidential cycles. With no strong central figure (the president or leading opposition candidate) drawing "casual" voters to the polls, party die-hards can drive ideological agendas. At mid-term time, voters tend to express frustration with the prevailing party in power, causing disruptions in the status quo - and lots of media hand-wringing.
Since 1980, the S&P 500 has not done much in aggregate in presidential election years, rising a subpar 2.8% on average. The years after presidential elections, however, tend to be honeymoon periods for politicians and investors. Since 1980, the S&P 500 has appreciated an average 13.9% in the years following presidential elections.
Mid-term years split the difference: since 1980, the S&P 500 has appreciated an average of 6.4% in mid-term election years. We never use these calendar statistics as predictors. But professional investors are aware of calendar tendencies. As such, they should be kept in mind.
It's too soon in earnings season to draw EPS conclusions, and too soon in 2014 to draw economic conclusions. Still, we have not yet seen anything to change our modestly bullish forecast for high-single- to low-double-digit stock market total return in 2014.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.