By Bill Stone of PNC Wealth Management
NEW YORK (
) -- Earnings season for the
companies will begin next week with the bulk of the earnings reports arriving in the coming weeks. S&P 500 earnings per share (EPS) are expected to be $17.17 for the first quarter, which would be a 38% increase year over year. This large year over year expected earnings increase is a function of multiple factors:
- First quarter 2009 S&P 500 earnings were the second lowest of this cycle, so the year over year benefits from relatively easy comparisons.
- S&P 500 core (excluding financials) earnings are expected to be up almost 27% year over year for the first quarter. Core earnings for the S&P 500 reached their lowest point a year earlier, so again this growth rate benefits from relatively easy comparisons.
- Revenues for the S&P 500 are expected to increase 6.4% year over year.
Our Outlook for First-Quarter Earnings
We expect the first quarter to provide another positive earnings surprise relative to expectations for the following reasons:
First-quarter expectations of 11.9% year over year growth for revenue, excluding financials and utilities, seems beatable, given our estimate that nominal GDP increased roughly 3% year over year in the first quarter. To put it in perspective, fourth-quarter 2009 nominal GDP increased 0.8% year over year, while S&P 500 revenues, excluding financials and utilities, rose 4.5%.
Taking a conservative stance, international revenues account for at least one-third of S&P 500 revenues. This benefits U.S. companies because they derive sales from faster growing economies around the globe. Even though the trade-weighted dollar has risen of late, it remains below year-ago levels, so we do not expect currency translation to be a significant detractor, yet.
Operating margins for the S&P 500, excluding financials and utilities, are expected to be 7.2% in the first quarter, compared with 7.7% in fourth-quarter 2009. A combination of seasonal factors -- first-quarter margins tend to be higher than fourth-quarter -- and continued cost control should combine to make consensus operating earnings conservative.
The combination of our forecast for continued economic growth in the first quarter and our expectations that corporate expenses remain contained leads us to believe that first-quarter earnings expectations again seem reasonable and beatable.
Possible Market Reaction
We believe the stock market should find support in the fact that corporations are beginning to see the positive effects of the economic rebound in terms of revenue and earnings growth. If the sales recovery continues as we expect, this should help provide the earnings leverage to support a sharp earnings recovery, which would bolster our view that the S&P 500 can produce at least $75 in EPS in 2010, with the risk likely to the upside. Stocks should be buoyed by valuations looking much more reasonable as the higher earnings outlook begins to become tangible.
As the stock market has recovered more than 75% from its lows, expectations have risen in sympathy. This leaves open the risk of disappointment and accompanying market losses. In the short term, the market looks overbought and susceptible to a pullback, but we think investors should focus on the big picture that the economy is improving, which should lead to higher earnings and support stocks over the longer term.
As we typically do occasionally during most earnings seasons, we'll be updating the progress and our views in response to the results in the coming weeks.
PNC Portfolio Positioning
The economic outlook should remain a constructive backdrop for the markets. Our view remains that the recovery from the Great Recession of 2008-2009 has begun and should be sustainable. Last week's March jobs report showing that the private sector has finally begun hiring again certainly bolstered our case.
Despite the above reasons to be optimistic regarding future stock market returns, there remain reasons to be somewhat cautious. While it remains our view that the economic recovery is sustainable and will lead next to expansion rather than another downturn, there remains risk to the downside in the form of a tentative housing market and precarious employment situation.
Our current recommended allocations attempt to reflect the more positive tone, while being mindful of the continued risks inherent in the market and economic outlook:
- a baseline allocation of stocks relative to bonds;a baseline allocation to international relative to domestic stocks;
- an allocation to emerging markets within the international component;
- a preference for high-quality stocks;
- a tactical allocation to leveraged loans within bond allocation; and
- an allocation to alternative investments for qualified investors.
--Written by Bill Stone in Philadelphia.
Bill Stone is the Chief Investment Strategist for PNC Wealth Management and PNC Institutional Investments with over $100 billion in assets under management. He is a member of PNC's Investment Policy Committee and is responsible for defining the asset allocations and portfolio strategies used throughout the organization to advise individual and institutional investors. Stone is a cum laude and honor's program graduate of the University of Dayton with a bachelor's degree in finance. He earned a master's of business administration from the Katz Graduate School of Business at the University of Pittsburgh. In addition, he holds the Chartered Financial Analyst? designation and is a Chartered Market Technician. Stone has been quoted in many publications including The Wall Street Journal, Financial Times, Barron's, Fortune, Forbes and USA Today. He is regularly interviewed by Associated Press and Reuters. He is also regularly interviewed on CNBC and Fox Business for his market insights.