With nearly 90% of the S&P 500 having reported earnings, now seems to be the perfect time take a look at the earnings scorecard for the 3rd quarter of 2014. While it’s been a while since anyone really got themselves worked up too much over earnings season outside of big names like Apple, the end of QE3 means that the financial media will have to find a new topic to gravitate towards and this week is going to be light on major economic news.
If there’s been one sector that surprised all forecasters with its performance in 2014, it's utilities where the Utilities Select Sector SPDR (XLU) began outperforming the broader market in January and now is up 24.99% YTD versus 9.93% for the S&P 500. In the third quarter, the utilities sector saw their earnings grow 2.8% compared to the broader market’s 7.6% and while the market typically does not reward the sluggards, in this case it’s made an exception. If earnings are going to be more important going forward, why are utilities outperforming so handily in 2014? Partly because among the companies that have offered forward guidance, their expectations for future growth are among the most stable.
So far 55 companies have offered negative guidance versus 18 with a positive outlook for the next quarter. The spread between positive/negative outlooks is skewed with tech stocks having the widest ratio (7.5x) while the lowly utilities sector has only one name offering forward guidance and of course, it’s positive. Given that analysts have trimmed their 4th quarter earnings forecasts since the end of the 3rd quarter by 53%, this stability clearly offers a lot of attractions in this brave new world without a backstop from the Federal Reserve but it comes with a heavy price.
Factset now estimates that utilities are one of the most expensive sectors based on the 12 month forward P/E ratio (16.9 versus 15.8 for the S&P 500.) While this strong performance, along with that of REITS, was attributed to either annual sector rotation or a quest for yield, the Factset Earnings Insight Report leaves little room for doubt that consistent earnings and expectations for more of the same are also playing their parts.
Using a list of ETFs with the biggest fundamental % gain last week shows another way to think about the power of dividends AND stable earnings in this market. ETFs offering exposure to preferred stocks and high dividends were among the biggest gains with the PowerShares Preferred Portfolio (PGX) and iShares S&P US Preferred Stock Fund (PFF) both making the short list and offering dividend yields in excess of 5.5% compared to the 1.8% offered by SPDR S&P 500 ETF (SPY). They also have heavy exposure to financials in common, 63% and 74% respectively and the earnings variability has weighed on both.
While the financial sector theoretically has the third highest earnings growth this quarter at 16.4%, if you removed J.P. Morgan it would drop to 2.8% putting it in-line with the utilities and even with a 5/4 positive to negative announcement ratio, investors aren’t feeling too generous to the banks. Continuing uncertainty over future lawsuits and settlements including the FOREX scandal has led to more cash hoarding to build up reserves while also lowering investor optimism. Factset’s 12 month forward P/E estimate for the financial sector is currently 13.5, the lowest for all the sectors of the S&P 500. Clearly, dividends are still king.
Happy Veterans Day and thank you for reading ETFG Perspectives.
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