Perhaps you are aware that S&P 500 (SPY) earnings are expected to grow 8.814% in 2012, from last year's $96.44 to a new record of $104.94. But do you know the breakdown of the growth by sector? Whether a bull or a bear, when looking for investment opportunities, it is useful to dig beneath the market-wide earnings estimates to discover which sectors are projected to drive growth. What you discover just might change your investment thesis.
For example, if you were interested in purchasing SPY but then discovered that just three of the S&P 500's sectors were projected to grow at rates greater than the index itself, it might change the way you decide to allocate your funds. Likewise, if you were thinking of shorting the S&P 500, you might find sector EPS growth useful in determining how to hedge your position. For instance, perhaps you enter an SPY short position paired against a long position in a sector experiencing strong growth.
With this in mind, let's take a look at the 2012 earnings estimates for each of the ten S&P 500 sectors and the index as a whole:
EPS % change 2011 to 2012
You might have noticed that just three of the ten sectors are projected to grow at rates faster than the index itself. Information Technology leads the way at 17.144% followed by Industrials and Health Care at 13.168% and 11.551% respectively.
With the Information Technology, Industrials (XLI), and Health Care (XLV) sectors having a combined weighting of 42.28% in the S&P 500, it might be tempting to purchase ETFs with exposure to those sectors, such as QQQ, XLI, and XLV, rather than SPY. This would provide you with exposure to the highest growth areas of the S&P 500 and, depending on how you allocate your funds, sacrifice very little in the way of dividend yield. SPY currently yields 1.89%, XLI currently yields 2.01%, XLV currently yields 1.97%, and QQQ currently yields 0.74%. If you were to choose this route, remember that Health Care has a 10.43% weighting, and Industrials has a 2.09% weighting in QQQ. This is important to keep in mind when deciding how to allocate your funds between the three ETFs.
A more aggressive investor might even choose to forego QQQ in favor of Apple (AAPL). Apple currently has an 18.64% weighting in QQQ and a projected dividend yield of 1.75%. Furthermore, because of its large and growing influence in the world of technology, it could be argued that as Apple goes, so goes QQQ. When overlaying charts of QQQ and Apple, the directional correlation between the two over the past several years is quite remarkable.
A word of caution for the bullish investor: despite a 17.144% projected growth rate in 2012, the forward P/E for Information Technology is actually higher than the 2011 P/E. The strong year-to-date price performance in tech shares might already be pricing in the extent of 2012 earnings growth.
Next, let's take a look at each of S&P 500's sector price-to-earnings ratios (P/E):
EPS % change 2011 to 2012
It is noteworthy that Information Technology is accompanied by Materials, Consumer Discretionary, Financials, and Telecommunication Services when it comes to forward P/Es higher than 2011 P/Es. The S&P 500 also joins the party with a forward P/E of 13.27 compared to 2011's 13.04. The bearish investor who believes that multiple expansion for the S&P 500 is not something that will last might look at the tables above and see short selling opportunities. In a world of $100+ oil, slow growth in much of the developed world, and an interconnected global economy that many believe can only survive on constant money printing, a long gold (GLD), short S&P 500, short QQQ, short slightly in-the-money Apple puts portfolio might be a way to express the opinion that equity markets have run too far too fast. Another way, of course, would be to simply short SPY.
Or, perhaps with volatility levels as low as they are (VIX under 15), an option strategy involving both puts and calls on the S&P 500 is the way to go. One possibility would be to execute the following strategy:
1. Sell December 22, 2012 SPY $142 calls for $7.54.
2. Buy the December 22, 2012 SPY $160 calls for $0.99 just in case the money printing gets a little out of control later in the year.
3. Take the remaining credit of $6.55 (ex-commissions) to purchase as many December 22, 2012 SPY at-the-money or slightly out-of-the-money puts as possible.
However, just as I cautioned the bullish investor earlier in this article, I would also like to caution the bearish investor with the following: never underestimate the ability of a long-biased equity market, operating in a world of low interest rates, money printing, and performance chasing money managers, to steal returns from the future. With that said, S&P 500 earnings estimates for 2013 are already available, and they are quite bullish. But before I present them to you, please put down any food you might be eating, for I fear you could begin to choke as laughter consumes you at the sight of these estimates:
EPS % change 2012 to 2013
If you believe S&P 500 growth will indeed accelerate to 13.379% in 2013, you might be interested in SPY's December 21, 2013 $145 calls, currently asking $11.23. Those calls get you long SPY with a cost basis of $156.23 (ex-commissions), just shy of its all-time high. If the S&P 500 does indeed earn $118.98 next year and growth looks like it will accelerate even further once the 2014 estimates come out, one could easily justify a 15 multiple on the $118.98 of earnings. This would put the S&P 500 at 1,784.70. Would I bet on this? Absent a few trillion dollars in new quantitative easing, no, I wouldn't. However, I do recognize that the bullish Kool-Aid is flowing strongly at the moment, and I'm sure there are plenty of investors who would take that bet.
In closing, I'd like to offer one final note of caution to both bullish and bearish investors: last summer, just before the major market indices took a nosedive, operating earnings for the S&P 500's first quarter of 2012 stood at nearly $26.50. Today, the estimate is $23.76. For the analyst community as a collective whole it pays to be bullish. If an analyst were to be bullish and wrong, the chances are good that most other analysts would be wrong as well. Therefore, the analyst would be more likely to get to keep his or her job. However, if an analyst were bearish and wrong, the chances are good he or she would stick out like a sore thumb. The result: it should not surprise anyone if that analyst loses his or her job. Please don't forget this as you examine earnings estimates as far as 21 months away (end of 2013). A lot can change between now and then.
Additional disclosure: I am long gold.