- We believe YTD valuation improvement in stocks is more likely the result of basic supply and demand than an upward revision off corporate prospects.
- Going into corporate reporting season, we're focused on whether the cyclical sectors show some signs of increasing activity.
- For the less cyclical sectors and consumer discretionary industries, we want to see if pricing holds up amid flattish demand and a tepid wage growth.
In about a week, corporate earnings reports will start to come in. As they do, we will try to match the torrent of operating results and management commentary with the prices of the stocks and that of the broader market. So far this year, the market has moved higher by about 6%. That run rate is a couple of percent ahead of the return we would expect by holding a constant PE multiple on forward earnings that are set to grow at 7%-8%. This valuation improvement is more likely the result of basic supply and demand for common stocks than an upward revision off corporate prospects.
Going into corporate reporting season, two broad themes shake out: Are the cyclical sectors going to show some signs of increasing activity? And then for the less cyclical sectors and some of the consumer discretionary industries, will pricing hold up amid flattish demand and a tepid wage growth? These basic themes have been in place for a while, but we do see a little more shifting and variations on the theme at the sector level.
With industrials having modestly underperformed this year (+3% vs. S&P 500 of +6%), investors will be looking for confirmation that revenue growth is picking up given that estimates for 2014 are back half weighted (1H consensus revenue growth of +4% vs. 2H revenue growth of +6%). The new order component of ISM manufacturing would suggest that domestic activity picked up in the second quarter, but management commentary will tell us if this is just catch-up from the weather induced weakness in the first quarter, or a sustainable pickup in industrial production. Emerging market growth deceleration will also be a topic in this and other sectors with companies with large revenue streams outside the U.S.
The economic backdrop for financial stocks has largely remained the same, with some surprises. Volatility in capital markets has remained weak, driving weak trading revenues, and housing metrics have remained stable. The surprises have been the accelerating strength of M&A activity, the 0.25% drop in the 10-year Treasury and modest signs of an increase in loan demand. The overall revenue environment should continue to show little improvement, and any earnings growth will come from familiar and tired sources: credit quality improvement, expense controls and share buybacks.
For retailers, analysts are focusing on inventory trends - the ability of firms to keep a level of inventory that avoids spilling sales, while avoiding excess goods that can lead to promotional activity. Positive commentary, backed by actual metrics, will lead to greater confidence in holding healthy profit margins for the remainder of the year.
In the technology sector, people will be looking for trends and commentary on enterprise spend to get a handle on the information technology budgets that constitute the revenues of much of the tech sector. An interesting thesis is that companies have put projects on hold while they figure out what part of their IT infrastructure might move to outsourced data centers and other cloud computing strategies. Any commentary or data points that both validates this thesis and shows signs of spending becoming unstuck would be very bullish for the "big ugly" technology names.
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