Attention Turns To Profits
Helped by solid economic news and the Federal Reserve's reiterated commitment to keep short-term interest rates low, the Dow Industrials and Dow Transports reached fresh all-time highs to reconfirm the bullish primary trend. Our buy lists have 93% to 96% in stocks.
With the Federal Reserve now committed to tapering its bond-buying program "in measured steps" in 2014 while keeping the federal funds rate near 0% "well past" the point at which the U.S. unemployment rate reaches 6.5%, investors' attention may shift away from Fed policy for awhile.
Recent news on the U.S. economy has been encouraging, with annualized growth in gross domestic product revised up to 4.1% for the September quarter. Slower growth is likely for the December quarter, but estimates for next year are rising. The Federal Reserve expects growth of 2.8% to 3.2% in 2014, up from about 2% for full-year 2013. The Fed expects the unemployment rate, 7% in November, to hit 6.5% in 2014.
However, among the 10 sectors of the S&P 500 Index, all except telecom and utilities have seen consensus profit-growth estimates for the December quarter revised lower since Oct. 1, according to Thomson Reuters. The ratio of negative to positive profit warnings is on track to be the worst since at least 1996.
Consensus estimates now project 7.8% year-to-year growth in per-share earnings for the S&P 500 Index for the December quarter, down from the 10.9% expected when the quarter began. Encouragingly, the consensus of 11.1% growth for full-year 2014 is down only marginally since Oct. 1.
Growth of 11.1% seems unlikely, as expectations of more than 12% growth in the second half of 2014 are likely to be cut. Also, with the consensus projecting 4% full-year revenue growth, double-digit profit growth would require a significant uptick in today's record-high profit margins.
Still, the 5% to 6% profit growth delivered by the S&P 500 Index over the last four quarters has been more than enough to sustain the bull market, and the typical S&P 500 company is growing profits faster than the capitalization-weighted index. The median company in the S&P 500 delivered 8.5% year-to-year growth in per-share profits in the most recent quarter.
With the median S&P 500 stock trading at nearly 19.2 times trailing earnings — above the nearly 20-year norm of 17.9 times — investors may be harder to please this earnings season. A near-term pullback would not be surprising, but we are inclined to view such a correction as a buying opportunity.