When investing, it is always good to step back, take a deep breath and assess the current macro environment.
I'll start off with the election, mainly because I feel that saying nothing about it would be to ignore the proverbial elephant in the room. The U.S. will have a divided government for at least two more years and politicians on both sides of the aisle are going to have to learn how to play nice in the sandbox. From an economic standpoint, avoiding the forthcoming fiscal cliff is the biggest short-term issue. But, a bipartisan agreement on debt reduction, taxes and spending could also go a long a way toward giving the markets confidence and potentially spurring stronger economic growth.
I'm not going to speculate on how this will play out. I do expect many investment newsletters and services to play off the fears of a worst-case scenario. My advice is to ignore them. When the facts are unclear-as they are now-following a strategy based on what Washington might or might not do can cause more harm to your portfolio than if you simply stayed diversified and looked long term.
There is also already chatter about which sectors and industries will do well or suffer as a result of the president's re-election. Health care reform will continue to be rolled out. Growth in defense spending could slow, though members of both parties have a long history of trying to protect programs that benefit their constituents and campaign donors. President Obama won't be friendly to the coal industry, which hurts railroads in turn, but global economic growth and the trend in natural gas prices are wildcards. Alternative energy should benefit, but this has been a risky sector to invest in. The Dodd-Frank Wall Street Reform Act will not be repealed, and its continuing implementation should be considered when looking at financial stocks. Keep in mind, however, that if the president wants to get legislation passed, he will have to make compromises on what gets done and carefully choose where to spend his political capital.
Shifting to third-quarter earnings, profits have been exceeding expectations, but sales have not. As of this morning, Thomson Reuters I/B/E/S says 63.4% of the 440 S&P 500 companies that have reported earnings so far beat their consensus estimates, while 26.4% have missed. This compares to the historical beat rate of 62% and miss rate of 21%. Conversely, 37.6% of reported S&P 500 companies have topped revenue expectations, while 62.4% have missed. In a typical quarter, 62% of companies top revenue forecasts and 38% miss.
Earnings are on pace to have declined by 0.2% in the third-quarter. This is better than the 2.1% decline analysts had feared at the start of October, but well below the 3.0% growth they had hoped for at the start of July. Revenues are on pace to decline 0.7%, which is worse than both the October 1 forecast for 0.1% growth and the July 1 forecast for 1.9% growth.
As you might suspect, analysts have been less upbeat about earnings. Though our earnings estimate revisions screens are good for finding potential buy and sell candidates, they also can provide insight on what analysts are doing. (I used our Stock Investor Pro program to look at these screens, which is updated more frequently than the screen results published on our website.) Currently, just 25 companies are passing our Earnings Estimates Revised Up 5% screen. (Whirlpool (WHR) is the only S&P 500 member passing the screen.) Conversely, 83 companies pass our Earnings Estimates Revised Down 5% screen. (Best Buy (BBY) and DuPont (DD) are among the 12 S&P 500 members identified by the screen.)
The declining revenues and earnings estimate cuts are not surprising given the slow pace of economic growth and macro headwinds. It is also possible that some businesses have curtailed spending ahead of the fiscal cliff. It is certainly hard to plan for projects if you don't know what your tax rates will be.
Valuations for stocks remain fairly attractive. S&P Capital IQ calculates a price-earnings ratio of 14.15 for the S&P 500. This equates to an earnings yield of 7.1%. In contrast, the benchmark 10-year Treasury note yields 1.63% and the 30-year bond yields 2.75%. The numbers are impacted by current Federal Reserve policy and valuations can stay out of whack for an extended period of time, but they do favor owning stocks.
Finally, a quick comment about the market's price trend. The S&P 500 tested its 200-day moving average today, after breaking below its 50-day moving average a few weeks ago. The trend is not positive, but I'm not surprised or overly concerned. The markets have had a good run this year, third-quarter earnings were not great, the deadline for avoiding the fiscal cliff is nearing and Europe's debt crisis has yet to be resolved. So, some weakness was likely to occur.
We're ultimately in the same situation we've been in throughout the year; things could either go right or wrong. Uncertainty does bring opportunity, however, and you won't see the "all clear" sign until stocks have rallied significantly higher.
Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.