Hutchens Investment Management: Austerity and Earnings

CONCORD, N.H. - April 23, 2013 - PRLog -- Austerity, does it work or doesn’t it?  This is an academic question which cannot be answered in the real world.  Unfortunately, in the case of US budget policy, the cuts from the sequester, which were never supposed to occur, are now reflected in politically sensitive areas, i.e. a 10% reduction in FAA air traffic controllers at airports resulting in further delays in this very visible annoyance.  Budget cuts to reduce the existing deficit will not happen because the political environment precludes any reduction even in the rate of growth in the deficit.  Europe has taken steps to institute austerity into the PIIGS, but the lack of economic growth will result in abandoning these plans before meaningful reductions can occur.  Sounds like “Back to the Future” for Europe, according to David Minor of Hutchens Investment Management.

First quarter earnings are under way and while the results are far from conclusive, it is the revenue numbers that are weak.  According to the Bespoke Investment Group, with about 200 companies reporting earnings thus far, 58% have beaten consensus, the exact beat rate for all companies for 4Q2012.  On the top line, 43.9% have surpassed estimates and although early in the reporting season if this level continued, it would be the weakest reading since the financial crisis.  Company guidance was generally negative going into earnings season and therefore companies are beating lower estimates.  Hopefully, these lowered estimates were reflected in pre-earnings stock prices.  

According to Morgan Stanley, 104 of the S&P 500 companies representing 33% of market capitalization have reported 1Q2013 earnings.  Aggregate earnings are tracking 4.1% above consensus (2.8% ex. financials), driven primarily by financials, technology, and consumer staples.   Revenues excluding financials have missed expectations by 0.3% led by technology, healthcare, and materials.  Looking into 2Q2013, the negative guidance remains at multi-year highs with the negative-to-positive guidance ratio at 4.7 compared to 3.7 for 1Q2013 and an average of 2.5 going back to 2005.  This negative guidance has driven analysts’ estimates lower.  Over the past month consensus S&P 500 estimates have been revised down 0.6% for 2013 and 1.1% for 2014 resulting in $112 for 2013 and $124 for 2014.  Technology and materials were leaders in the downward revisions in both years.  

Our investment strategy is a full position in equities.  The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a correction.  The magnitude and duration of a correction will depend on the earnings shortfall and its offsetting impact to Fed expansionary policy.  Longer-term earnings growth should rebound later in the year and along with a dose of inflation may be the ultimate catalyst for a sustainable bull market and deficit reduction.