SPY: The Myth of a Decline in Corporate Earnings

The media are quick to point out the year-over-year decline in company profits. For the largest 500 companies in the U.S., the collective drop-off is -16.6% on 460 corporate earnings reports.

So why has the S&P 500 SPDR (SPY) still managed to rally 4.0% since earnings season began on April 7, 2008? Perhaps it might have something to do with 7 out of the 9 major economic segments posting gains!

Energy, Materials, Staples and Technology all posted double-digit growth from the year prior. Earnings in the Utilities segment jumped 7%, while Industrials grew roughly 6%. Health Care increased profits by approximately 5%.

So how did the earnings picture for the entire S&P 500 become so bleak? The usual suspects proffered abysmal year-over-year results.

For example, diversified financials didn't just witness slow growth, the sector experienced unprecedented losses. Earnings declined -85%. (And it was much worse for the banks!)

Retailer profits may only have fallen -16% in aggregate, but consumer durables that include things like furniture and appliances witnessed "crazy" weakness (-240%+). In brief, the consumer has not been buying small ticket or big ticket items.

For those that believe that the worst may be over, or for those who wish to bargain hunt in the wreckage, you'd have to look to early business cycle leaders (e.g., financials, consumer discretionary). Historically, the best time acquire shares in these sectors is half-way through a recession. Are we at a mid-point of a recessionary environment yet?

Another way to look at the effect of current profit growth on stock price appreciation is to look at the gains for each sector since earnings season began. Since the close of market on Monday, April 7, 2008:

Energy SPDR (XLE) 10.4%
Technology SPDR (XLK) 9.3%
Materials SPDR (XLB) 6.4%
Consumer Discretion (XLY) 5.4%
Industrials SPDR (XLI) 3.2%
Utilities SPDR (XLU) 2.9%
Consumer Staples (XLP) 1.1%
Financials SPDR (XLF) 0%
Health Care SPDR (XLV) -1.1%

For those who believe current earnings have an effect on future stock appreciation (depreciation), there are a number of take-homes for the sector results. First, the areas making the most money year-over-year -- Tech, Energy, Materials -- did post the most impressive gains since Q1 results began coming in.

Second, as poorly as consumer discretionary companies did in Q1 2008, bargain hunters are seeing value in the beaten-down arena. Current losses have not hampered the apparent progress of the S&P Consumer Discretionary Fund (XLY).

Third, how can one explain the general lack of interest in health care and consumer staples, in spite of robust earnings growth? The likely answer must rest with an investor belief that the recession will be mild. After all, investors are not flocking to the traditional safe havens of an early stage economic decline.

Finally, while financials may not have gone anywhere, a 0% return is better than should have expected. Based on the unbelievably poor showings for year-over losses, record write-downs and dire warnings for the future, one might be encouraged with the ability of financials to have "held serve."

Disclosure: The author's firm may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[User 193849]

Good work!!

[The WholePicture]

Just out of curiousity, how do appliance & furniture sales drop 240%? Sounds like most of last year's customers must have returned last year's purchases for a refund. I agree, that is "crazy" weakness.

[bearfund]

The lack of interest in health care and consumer staples has clear and simple explanations. First health care. In case you hadn't noticed, it's an election year, and there's a lot of noise being made about socialised medicine. As ever, there will probably be winners and losers among the health care companies, but it's hard to know which will be which. And most sensible investors assume the sector will be an overall loser, given the government's thieving ways and poor record of competence. Too much risk, too little reward. Then consumer staples. The lack of interest here is probably because these companies have costs (cough, energy, cough) that investors would rather not have exposure to. Instead, we'd much rather just own the raw materials and foodstuffs these companies use as inputs. We're confident in the supply and demand picture, but we're much less confident that these companies can control costs well enough to capitalise on the higher prices. The closer to the mine or the farm you are, the better, and ownership of metals and grains themselves may be best of all. That's exactly what Mr. Market has been saying for the past year, as commodities have soared and consumer staples have seen only weak interest.