Crumbling Foundation?

Will the S&P 500 2012 earnings projections start to show some cracks in the foundation?

In a recent post, you probably picked up on my position regarding the fact that things must be so good in today’s economy that S&P is projecting record earnings for 2012. I read recently that Barclays Capital has two thoughts as to how earnings have been so good, yet the economic environment feels so terrible. “In our view, there are two primary explanations: 1) an increased reliance on overseas sales (particularly emerging markets) relative to prior business cycles; and 2) reasonable leverage in the nonfinancial corporate sector prior to the crisis, which allowed for a symmetrical recovery…”

I’m not going to elaborate on the second point (its technical balance sheet type stuff and frankly not as much fun to write about), but I do want to make some comments on point number one. First of all, I agree fully with them. Secondly, I can’t help but to believe this is the same reason, which will keep the S&P 500 companies from meeting these ambitious 2012 targets. A quick review of revenues from some of the bigger companies in the S&P500 show percentages ranging from 15% to 55% of revenues generated from international sources. In my world, the dots are easy to connect. Europe will be in a recession, emerging markets sell to Europe, and so emerging markets will be affected in some manner negatively. In summary, US company earnings have been strong on the back of overseas sales (i.e. emerging markets) and emerging markets have a good probability of being impacted negatively by the European crisis. Once again, all of this adds up to earnings disappointments in 2012.

Now let’s take a look at some of these bigger companies influencing the S&P500. First, ExxonMobil and Chevron. Both are related to oil and with projections (my own) that we will see lower oil prices at least in 1H 2012; this will have a negative impact on their stock prices. Next, let’s look at Apple and IBM. Apple earnings have grown at a ~65% annual clip the past 5 years. IBM has also grown at a ~17% clip over this same time period. Imagine if your salary grew at these same rates year after year. Life would be good, but you couldn’t expect that kind of a pace to continue. Please don’t misunderstand me here, I am by no means saying these are bad companies with bad products and services, I just don’t think it’s possible for any company to continue on this kind of a pace and without some kind of correction. It just might be the global issues that serve as the catalyst.

As I’ve said before and you will hear me say many more times, I like to stack the odds in my favor and right now I just can’t see a high probability that the S&P500 as a whole can meet these optimistic forecasts. Since I don’t like to take unnecessary chances with my money, I would be underweight stocks in any portfolio.

I had some more data and statistics, but an unfortunate loss of the information has caused me some heartburn this week. I’m hoping to start sharing some more opinions in upcoming articles about specific investments and still plan to share what I believe is going to be one of the best bets for the next several years.

Happy Holidays!

Joel Fink
Joel.fink@yahoo.com