www.morganmarkets.com North America Equity Research 11 October 2012 S&P 500 3Q EPS: Bad Does Not Mean Broken Domestic Getting Stronger; Int'l Potentially Troughing; 14 Ideas Portfolio Strategy Thomas J Lee, CFA AC (1-212) 622-6505 [email protected]Katherine C Khor (1-212) 622-0934 [email protected]J.P. Morgan Securities LLC See page 54 for analyst certification and important disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. With 3Q12 results upon us, the critical issue is whether these weak results point to (i) earnings having peaked in this cycle already and we are tipping into a global recession (bad, obviously) or (ii) 3Q reflects a trough in the cycle and earnings should accelerate (given strengthening in the US coupled with stabilization in Europe and China). We subscribe to the latter view and highlight some perspectives below: Global PMIs are inching upwards, a signal supported by steepening yield curves… Global PMIs have begun to improve (US above 50) and J.P. Morgan economics Nowcasting tool sees PMIs gaining in October (see Figure 2), in line with their view that businesses continue to expand. A forward rise in the PMIs is supported by the steepening of the 30yr vs 10yr curve which historically has presaged further gains in PMIs (see Figure 6). …a positive for Industrial and Technology earnings, which account for 90% of the Q/Q decline in 3QE EPS. This points to future improvements in Q/Q and Y/Y growth for both Industrial and Technology earnings, both of which are closely linked to movements in the PMI (see Figure 3 and Figure 4). Combined, Industrial and Technology account for $0.56 of the Q/Q decline in EPS (3QE vs 2Q), or 90% of the decline (see Figure 1). Domestically oriented companies are on balance lifting estimates, drag is global (Figure 17). Those companies with lowest international exposure (lowest third) saw 3Q estimates gain 1% on average since June while those with the heaviest saw an 11% decline. While this is not entirely surprising (and our thesis for 2012), this bolsters our view that investors should focus on US-centric Cyclicals in 2012. Financials are likely to be one of the bright spots in 3Q, and recall that US credit agencies purge foreclosures and bankruptcy filings after 7 years—2005 was the peak year of filings at 2mm (see Figure 14). Financials are one of three groups that saw estimates raised in 3Q (Figure 18) reflecting improving credit trends and loan demand (along with US housing and employment, etc.). But a tailwind is building in 2013, in our view, which is the resetting of the credit scores for millions of Americans. The peak year of personal bankruptcies was 2005 and those records are removed from credit reports after 2012. Thus, beginning in 2013, we should see rapid improvements in the credit quality of millions of Americans. Discretionary earnings (and domestic Cyclicals) should get a lift from the record $5.3T wealth effect in 2012 (Figure 10), boosting 2013 GDP by 1.6%. The combined $5.3T “wealth effect” in 2012 from the rise in equities ($3.6T) and housing ($1.7T) is the largest such increase in the past 12 years (and exceeds 2003’s $5.1T). It also reverses about half of the cumulative losses since 2007 ($13T lost in 2008 alone). Our economists estimate that for each $100 in wealth, $5 is spent on consumption in the following year—or $265b incrementally, representing 1.6% lift to 2013 GDP. This should directly boost Consumer Discretionary earnings which closely track US consumer confidence (Figure 13). And we would argue the continued rise in confidence, despite corporate cautiousness, is a direct result of this “wealth effect.” Source: J.P. Morgan and Bloomberg. S&P500 (LHS) 10/11/12 1,433 Cyclicals (RHS), 10/11/12, 113 Defensives (RHS) 10/11/12 112 95 100 105 110 115 120 1,250 1,300 1,350 1,400 1,450 1,500 12/11 2/12 4/12 6/12 8/12 10/12 12/12 100=start of year S&P500 (LHS) Cyclicals (RHS) Defensives (RHS) 1Q12 2Q12 3Q12 QTD YTD S&P500 12% -3% 6% -1% 14% Cycl (Mat, IT, Disc, Ind) 14% -5% 5% -1% 13% Near- Cycl (Ener, Fin) 12% -7% 8% 1% 14% Def (Stpl, HC, Tel, Util) 3% 5% 3% -0% 12% Valuation: 2012E 2013E S&P500 Level 1433 — EPS $105 $110 P/E (current) 13.6x 13.0x Div Yield 2.2% 2.4% Short-term Target (by election day): S&P500 1495 — P/E — 13.6x Year-End T arget: S&P500 1430 — P/E — 13.0x
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www.morganmarkets.com
North America Equity Research11 October 2012
S&P 500 3Q EPS: Bad Does Not Mean BrokenDomestic Getting Stronger; Int'l Potentially Troughing; 14 Ideas
See page 54 for analyst certification and important disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
With 3Q12 results upon us, the critical issue is whether these weak results point to (i) earnings having peaked in this cycle already and we are tipping into a global recession (bad, obviously) or (ii) 3Q reflects a trough in the cycle and earnings should accelerate (given strengthening in the US coupled with stabilization in Europe and China). We subscribe to the latter view and highlight some perspectives below:
Global PMIs are inching upwards, a signal supported by steepening yield curves… Global PMIs have begun to improve (US above 50) and J.P. Morgan economics Nowcasting tool sees PMIs gaining in October (see Figure 2), in line with their view that businesses continue to expand. A forward rise in the PMIs is supported by the steepening of the 30yr vs 10yr curve which historically has presaged further gains in PMIs (see Figure 6).
…a positive for Industrial and Technology earnings, which account for 90% of the Q/Q decline in 3QE EPS. This points to future improvements in Q/Q and Y/Y growth for both Industrial and Technology earnings, both of which are closely linked to movements in the PMI (see Figure 3 and Figure 4). Combined, Industrial
and Technology account for $0.56 of the Q/Q decline in EPS (3QE vs 2Q), or 90% of the decline (see Figure 1).
Domestically oriented companies are on balance lifting estimates, drag is global (Figure 17). Those companies with lowest international exposure (lowest third) saw 3Q estimates gain 1% on average since June while those with the heaviest saw an 11% decline. While this is not entirely surprising (and our thesis for 2012), this bolsters our view that investors should focus on US-centric Cyclicals in 2012.
Financials are likely to be one of the bright spots in 3Q, and recall that US credit agencies purge foreclosures and bankruptcy filings after 7 years—2005 was the peak year of filings at 2mm (see Figure 14). Financials are one of threegroups that saw estimates raised in 3Q (Figure 18) reflecting improving credit trends and loan demand (along with US housing and employment, etc.). But a tailwind is building in 2013, in our view, which is the resetting of the credit scores for millions of Americans. The peak year of personal bankruptcies was 2005 and those records are removed from credit reports after 2012. Thus, beginning in 2013, we should see rapid improvements in the credit quality of millions of Americans.
Discretionary earnings (and domestic Cyclicals) should get a lift from the record $5.3T wealth effect in 2012 (Figure 10), boosting 2013 GDP by 1.6%. The combined $5.3T “wealth effect” in 2012 from the rise in equities ($3.6T) and housing ($1.7T) is the largest such increase in the past 12 years (and exceeds 2003’s $5.1T). It also reverses about half of the cumulative losses since 2007 ($13T lost in 2008 alone). Our economists estimate that for each $100 in wealth, $5 is spent on consumption in the following year—or $265b incrementally, representing 1.6% lift to 2013 GDP. This should directly boost Consumer Discretionary earnings which closely track US consumer confidence (Figure 13). And we would argue the continued rise in confidence, despite corporate cautiousness, is a direct result of this “wealth effect.”
Thus, there are some reasons to expect rising S&P 500 estimates, something suggested by the continued rise in economic momentum indicators (like the Citi Eco Surprise Index, see Figure 15). The US CESI (CESIUSD Index GP <<GO>>) has been rising since summer of 2012 and is currently at 43. Since 2007, whenever the CESI has been above 40, EPS revisions have moved positively 4 of the 5 times (one time revisions went flat) and we believe the arguments above point to reasons to see estimates revised higher in coming months. More arguments are covered in this report.
Bottom-line: While equities have faltered in the past 4 weeks, the positive thesis remains intact – 14 ideas. Investors are understandably nervous given the heavy negative pre-announcements (see Figure 21) and the overall weakness in markets. We do not believe US earnings have peaked (S&P 500 EPS likely peaks around $145-$160 per share (see “US Equity Strategy FLASH: Weak 2H...” dated 9/27/12). And, as a consequence, we view recent weakness in stocks as an attractive entry point. We have identified 14names that are domestically focused, beat EPS recently and have insider buying. The tickers are: KR, WFC, CVS, M, UNP, FITB, STI, BBBY, CTAS, EQR, KEY, GPC, NOC and NI (see Figure 20).
The problem in 3Q is 4 sectors: Energy and Materials (Commodities) and Industrials and Technology (China and Europe)…global bad, US-centric good
Take a look at Figure 1 below which highlights quarterly EPS contributions by sector for 3QE (and other quarters as well). Specifically, we highlighted the 4 sectors that are really driving the weak Y/Y and Q/Q results:
Commodity-related: Basic Materials is the largest driver of the Q/Q decline in 3Q12E EPS and that is a simple function of declining prices (more than volumes). Similarly, Energy EPS is also following lower commodity prices.
Downturn in European and China demand: Technology and, to a lesserextent, Industrials are weak Q/Q reflecting the downturn in demand seen in Europe (where economies have been in recession) and China (where economy has been decelerating).
In other words, 3Q is not telling us anything we don’t already know.
Figure 1: Quarterly EPS Forecasts, 2010-2013E
$ per share; Q/Q >1% shaded green, Q/Q <1% shaded red
#1: Global growth poised to move higher, boosting Industrial & Technology EPS
The improvement in September PMIs bolsters our economists’ expectations that global growth is poised to move modestly higher. As shown in Figure 2 below, their Nowcast (which is more real-time than September PMIs) shows this strength has continued in recent weeks. There is data supporting this: new orders components were promising, US Sept labor report was solid, and it now seems that the capital goods declines in recent months were more an “air pocket” (Bruce Kasman’s words).
Figure 2: J.P. Morgan Nowcast Shows Global Growth Strengthening…
Source: J.P. Morgan, from “Global Data Watch”dated 10/5/12.
Industrial and Technology EPS should start improving…
Notice how closely Technology (Figure 3) and Industrial EPS (Figure 4) have followed changes in PMI. This suggests to us that the slump seen in both sectors should soon recover. As highlighted by the arrows, the Global PMI is recovering (y/y growth rates).
Figure 3: Technology EPS and Global PMI (% chg y/y)
Source: J.P. Morgan and Bloomberg.
Figure 4: Industrials EPS and Global PMI (% chg y/y)
Source: J.P. Morgan and Bloomberg.
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30Y vs 10Y yield curve steepening supports further gains in PMIs...
Long-term yield curves have steepened recently (see Figure 5) in many regions. We have highlighted US, Germany and Spain in the figure below. Note that Spain’s long-end curve basically inverted earlier this year (a sign of recession, which indeed is happening). We like to look at the longer-end of the curve as it is less subject to actions by central banks.
Note how historically changes in the yield curve (long-end) have presaged gains in the PMI. We have plotted the US data below in Figure 6 and, as shown, the steepening of the curve is the steepest since mid-2011.
Recall that since mid-2011 US economic momentum has improved considerably. We believe the recent steepening suggests a similar improvement in coming months.
Figure 5: Yield Curves Are Steepening... 30Y vs 10Y Spreads
Source: J.P. Morgan and Bloomberg.
Figure 6: Does YC Lead ISMs? Chg in 30Y vs 10Y and Change in PMIy/y delta
#2: Industrial metals recovering, positive for Energy & Basic Materials EPS
While headline commodity prices continue to show mixed results (see Figure 7), the “common factor,” which measures underlying demand, continues to improve. We believe this supports the improvements in PMI noted previously.
Figure 7: The “Common” Factor Among Commodity Prices Is Improving...
Source: J.P. Morgan, from “Global Data Watch” dated 10/5/12. Note: Oil is Brent while industrial metals and agriculture are the
J.P. Morgan commodity curve indexes. Common movements for each are given by the common factor scaled by each commodity’s
individual loading weight. The idiosyncratic movement is the residual.
Energy and Basic Materials EPS closely track moves in industrial metals indices… implying improvements in coming quarters for EPS
One of our favorite series to track industrial metal demand is the DJ-UBS Industrial Metals index (DJUBSIN Index GP <<GO>>) and this index has been improving since bottoming in August 2012.
This bodes well for improvements in Basic Materials and Industrials EPS in coming quarters as shown in Figure 8 and Figure 9.
#3: 2012 US wealth effect $5T, largest since before 2004 – US consumers are gaining confidence, which supports higher Discretionary EPS
$5.3T wealth effect in 2012 (housing and stocks), largest in past 12 years
The wealth effect is the improvement for households from change in the value of assets. The most significant assets for US households are equities ($22T held) and housing ($18T held). For equities, the wealth effect is the gain from stock appreciation (we use the S&P 500 as the proxy) and housing (Case-Shiller gain).
The data is compiled in Figure 10 below. Note that in 2012 equity gains are $3.6T and US housing gains are $1.7T, or $5.3T in total.
This is the largest increase in the past 12 years. The next largest increase was in 2003, which was $5.1T.
Historically, for every $100 rise in wealth, J.P. Morgan estimates that this results in a $5 increase in consumption over the following year. This implies about $265b increase in consumption in 2013, or 1.6% lift to GDP.
Figure 10: US Wealth Effect (2000 to 2012)
Source: J.P. Morgan, Bloomberg and Federal Reserve. Note: 2012* reflects annualized data. Prior yr ending balance in HH and NP
holding of corporate equities reflects Federal Reserve Flow of Funds (Z1) "households and nonprofit organizations, directly and
indirectly held corporate equities; asset." % change in stock market reflects S&P 500 data.
Wealth Effect from Stock Market Wealth Effect from Housing Total Wealth Effect
First improvement in housing wealth effect since 2006
The combined positive wealth effect from equity markets and home equity for US households in 2012 is $5T, comprising $3.6T from equities (Figure 11) and $1.7T from US housing (Figure 12).
For the first time since 2005, US home prices have risen YTD and, as we have written in several pieces (see “US Housing Food Chain IV” dated 8/29/12), we see this recovery as not only sustainable but only 1 year into a 3- to 5-year cycle.
This $5T figure is the largest since before 2004 (or 8 years) and reverses the massive drags on wealth effect from 2007 to 2011. Consider that in 2008 the wealth effect was a staggering $13T in losses.
Source: J.P. Morgan, Bloomberg, Federal Reserve Flow of Funds. Note: Reflects
Federal Funds Flow of Funds (Z1) data, "households and nonprofit organizations,
directly and indirectly held corporate equities; asset." While % change in stock market
reflects S&P 500 data.
Figure 12: Housing Wealth 2012 – $1.7T$ billions
Source: J.P. Morgan and Bloomberg. Note: 2012* reflects annualized.
Impact on US consumption may be $250b in 2013...
According to our US economists, the impact on consumption from this wealth effect is about 5%—that is, about 5% of each $1 of higher wealth is spent over the next year.
This implies a $250b tailwind from the $5T wealth effect. This works out to a 1.6% lift to US GDP in 2013 (on $15T economy).
We have not heard investors talk about the potential boost to 2013 growth (and this is not in our base case) but this could arguably offset a portion of the US fiscal cliff.
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…and this argues for further improvements in Consumer Discretionary EPS
Tailwinds remain strong for companies with US exposure. The wealth effect, in our view, explains in part why US consumer confidence continues to strengthen even as the global economy remains sluggish.
But given the $5T wealth effect noted above, we believe US consumer confidence is poised to gain further in 2013.
Such gains in consumer confidence (see Figure 13) suggest we should see Consumer Discretionary EPS continue to expand at a healthy pace. Since 2004, the relationship between these factors has been significant.
Figure 13: Two-Year % ∆ in Consumer Confidence vs Discretionary Sector EPS
Two-year % change in consumer confidence and the level of Consumer Discretionary EPS
#4: Remember the number 7 – peak ’05 bankruptcies now being purged from credit record…positive for Financials
When an American files for bankruptcy, his/her credit record reflects this event for 7 years and is then purged. This is very important.
Why? Take a look at Figure 14 below. US personal bankruptcy filings peaked in 2005 at 2.039mm (in retrospect, this was a bad sign).
Using the 7-year guideline, this implies that after 2012, millions of Americans should see their credit scores dramatically improve (the bankruptcy is purged).
This sets the stage for more Americans to meet the underwriting standards of banks (which are currently only approving Americans with higher FICO scores) and would further support a recovery in the US housing market.
Figure 14: Personal Bankruptcy Filings
Since 2000
Source: J.P. Morgan and the American Bankruptcy Institute.
Separately, we believe that US Financials will have many positive things to say about improving delinquencies, etc.,thus, further setting stage for credit standards to ease
Financials will likely be one of the bright spots in 3Q. Delinquency trends have been improving throughout the last 3 years but we believe in 3Q improvements gained at a faster pace and moved to new cycle lows.
This suggests that bank staff may need to be reallocated, away from “workout/collections” towards originations, and would be another step towards accelerating credit expansion.
Personal Bankruptcies2005
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Americans whose bankruptcy is purged
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#5: CESI is turning up and associated with positive S&P 500 EPS revisions
While we had highlighted the strong relationship between economic momentum (our favorite is the Citi Economic Surprise Index, CESIUSD Index GP <<GO>>) and EPS revisions, the relationship is apparent when looking at Figure 15 below:
Note how, in 5 instances since 2007, an upturn in the CESI was followed by an improvement in the trend of EPS revisions.
The improvement in CESIUSD reflects all of the points in the discussion in previous sections (Global PMIs bottoming, US demand strengthening, US housing accelerating).
So far, EPS revisions have not moved upwards, and this lag has been seen in the previously highlighted examples.
The key takeaway, however, is that we do not believe S&P 500 EPS is peaking. Rather, we think it is reflecting the shift in momentum from global growth to US domestic demand.
Figure 15: EPS Revisions vs. Economic Surprise Index Suggests Future Positive Revisions
EPS revisions are for forward 1 qtr as of each point; CESIUSD Index
EPS cuts more pronounced for companies with more “non-US” exposure…
It is important to keep in mind that US-oriented companies (those with heavier US exposure) have seen modest EPS estimate revisions. That is, the bulk of negative EPS estimate revisions has been attributable to those with greater share of sales overseas. Take a look at Figure 16 and Figure 17 below.
The groups that saw positive EPS estimate revisions in the quarter are Financials(particularly those US-oriented), Utilities, Telecom and Energy (US-oriented).
Those with heavy non-US exposure (red dots) saw greater overall EPS estimate cuts since 6/30/12 for 3Q.
On the other hand, take a look at those with little international exposure. As one can see in Figure 17 the reductions in EPS estimates for those with low international exposure have been significantly more modest than for those with high international exposure.
Figure 16: Sector Analysis – % Change in 3Q12 Net Income Estimates Since 6/30/12 vs % of Sales InternationalBetween 6/30/12 and today
Source: J.P. Morgan and FactSet.
Note: % of Sales International. Data is from Dubravko Lakos-Bujas, J.P. Morgan Head of US Quant Strategy.
Figure 17: % Change in 3Q12 Net Income Estimates Since 6/30/12 Based on % Sales InternationalBetween 6/30/12 and today
Source: J.P. Morgan and FactSet.
Note: % of Sales International. Data is from Dubravko
Lakos-Bujas, J.P. Morgan Head of US Quant Strategy.
Looking at this across sectors, Cyclicals see biggest EPS reductions into 3Q
Looking at 3Q specifically by sector, we have made a simple waterfall chart below. What one can see is that Technology and Energy account for 2/3 of the EPS cut since the start of the quarter.
In other words, the reduction in 3QE EPS is heavily concentrated. So of the $1.30cut in 3QE EPS since 6/30/12, Technology and Energy represented the majority.
Estimates were actually modestly increased overall for Telecom, Financials and Utilities.
Figure 18: Sector Contribution Analysis – S&P 500 3Q12 EPS Estimate Revision Since 6/30/2012Between 6/30/12 and today
Source: J.P. Morgan and FactSet.
Figure 19: % Contribution of Sectors to 3Q12E EPS Revisions vs Earnings Weight
Source: J.P. Morgan and FactSet.
$26.27 -$0.48
-$0.38
-$0.19
-$0.15
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-$0.01 +$0.01 +$0.03+$0.09 $24.97
S&P500 3Q12E Est as of 6/30/12 S&P500 3Q12E Est as of Today
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NEGATIVE:revisions are larger than earnings
POSITIVE:revisions are smaller than earnings weight
On balance, we think the S&P 500 will deliver earnings that will, on balance, be better than expectations. So, what should investors consider? We have identified 14 names that are domestically focused, beat EPS recently and have insider buying. We used the following criteria:
The stock is in the S&P 500;
It is in lowest quartile of exposure to international sales for its specific sector;
In the past 6 months, there has been insider buying; and
The company has exceeded Street forecasts on EPS beats for each of the last two quarters (1Q12 and 2Q12).
On average, these 14 names have 12% upside to J.P. Morgan target prices (for those that are covered) and a 2013E P/E of 11.3x.
Figure 20: 14 Domestically Oriented Stocks
Priced as of 10/10/12
Source: J.P. Morgan and Bloomberg.
% of Sales International Data is from Dubravko Lakos-Bujas, J.P. Morgan Head of US Quant Strategy.
Negative preannouncements are high at 73% of total, consistent with past 3 quarters...
Negative preannouncements for the 3Q earnings season continue to be elevated, reflecting the macro headwinds from the global economy. Negativepreannouncements persist at 73% of all preannouncements as of 10/10/2012, above the prior three quarters’ relatively elevated readings.
Figure 21: Negative and Positive Preannouncements % of Total Quarterly Preannouncements, as of 10/10/2012 Director’s Report
Source: J.P. Morgan and Thomson Reuters.
52% of companies have beaten 3Q12 results…
Early results show 3Q12 EPS beats at around 52%, which is below recent quarters, particularly 2Q12. 2Q12 started off stronger with 68% beating through the first few weeks but by the end of the quarter 2Q12 proved to be in line with past quarters.
Figure 22: % of Companies Beating on Top Line and EPS
% of S&P 500 that has reported, beating on top line and EPS, 3Q12
Source: J.P. Morgan and FactSet.
3Q12 "% cos beating (as of early in earnings season)” is based on 25 companies that have reported earnings as of 10/8/12.
2Q12 "% cos beating (as of early in earnings season)” is based on 25 companies that have reported earnings as of 7/11/12.
S&P 500 3Q12 top-line growth expected to be down yoy with earnings growth of 2% yoy
We continue to see the headwind effects of the Eurozone crisis, China slowdown and now-weakening U.S. momentum, which are combining to generate weak revenue growth in 3Q12.
As evidenced in Figure 23, growth has certainly slowed. YoY revenue growth for the S&P 500 is expected to be down in 3Q12 following downward YoY trends seen in 2Q12.
However, if we consider the S&P 500 ex-Energy (see Figure 23), YoY revenue growth is expected to come in flat in 3Q12. While such is even below recent trends of positive growth seen in S&P 500 ex-Energy since 2010, if we exclude Energy in our calculations, most of the other sectors look less dim.
Figure 23: YoY % Change in Revenue Growth
Source: J.P. Morgan and FactSet.
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Similarly, earnings growth in 3Q12 is expected to be weak, at 2.4% YoY. This is a decrease from 4.5% just a quarter ago, and down from 17.9% in 3Q11.
However, when we consider earnings growth for the S&P 500 ex-Energy, 3Q12 earnings growth is expected to be 5.9% YoY, which is below YoY growth since 1Q10.
The macro environment remains relatively troubling as 4 of the 7 indicators detailed in Figure 25 worsened in 3Q12 as compared to 2Q12. In particular, improvements were seen in ISM Non-Manufacturing New Orders as well as ABI Residential Billing.
Figure 25: MACRO – Trends Indicate Mixed Momentum in 3Q12
Trend in macro indicators
Source: J.P. Morgan estimates and J.P. Morgan Economics.
Micro indicators
Figure 26 lays out several key micro indicators and their respective performance in each quarter versus recent trend.
Following relative declines in 2Q12, micro indicators were once again relatively weak in 3Q12. Of the micro indicators below, US Machine Tool Orders, the Case Freight Index, Corrugated box shipments, Air Freight Traffic, Auto Sales and Credit card charge volumes all slowed or worsened in 3Q12.
On the other hand, Housing Permits and Income Tax Withholdings improved in 3Q12 relative to 2Q12, highlighting the strengthening in the microeconomic environment, particularly as housing continues to recover from historic lows (see “US Housing Food Chain IV” dated 8/29/12).
Note the recent upwards curl of the YoY change in income tax withholdings (trailing 120-day average). As seen in Figure 27 there has been a recent uptick in income tax withholdings implying that average salaries and wages are higher overall.
3Q11 4Q11 1Q12 2Q12 3Q12
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Index of Leading Economic Indicators (yoy %∆) 5.0 3.9 2.7 1.6 1.8 3.3
• trend worse worse worse worse better worse
Index of Coincident Indicators (yoy %∆) 2.2 2.7 2.4 2.9 2.5 2.5
• trend stable stable worse worse worse stable
ISM Manufacturing (New Orders minus Inventory) -0.3 8.2 6.0 9.2 -1.7 5.8
• trend worse better worse better worse worse
ISM Non-Manufacturing New Orders 54.4 53.8 59.8 54.1 55.2 55.5
• trend stable stable better worse better stable
China Industrial Production (yoy %∆) 14.1 13.1 11.9 10.2 9.3 12.3
• trend stable slowing worse worse worse better
ABI - Commercial Billing 50.0 53.7 54.4 50.5 46.6 52.2
• trend stable better stable worse worse worse
ABI - Residential Billing 46.9 53.5 52.6 49.5 51.4 50.6
Despite appearances, 3Q12 is expected to be a decent quarter for Cyclicals
We have compiled bottom-up revenue and net income forecasts in Figure 28 below. Notably, despite the numerous headwinds, there are several industries that still should show solid growth.
Many key Industrials and Technology groups like Construction, Electrical Equipment, IT Services and Computer & Peripherals are expected to post solid y/y gains on fairly strong sales growth. Industrials as a sector is expected to grow earnings by 0.8% YoY and top line by 2.4% YoY.
There are some signs of weakness is several sub-industries, mostly within the Materials and Discretionary sectors. Particularly large drags are expected in Metals & Mining, Paper & Forest Products, Automobiles and Diversified Consumer Services.
Figure 28: 2Q12 and 3Q12E YoY Revenue and Earnings Growth – Cyclicals
2Q12 and 3Q12E YoY Revenue and Earnings Growth – Cyclicals
Source: J.P. Morgan and FactSet.
Revenue Net Income
2Q12 vs.
2Q11
YoY %
chg
3Q12E
vs. 3Q11
YoY %
chg
2Q12 vs.
2Q11
YoY %
chg
3Q12E
vs. 3Q11
YoY %
chg
Cyclicals 5.5% 4.5% 7.8% 2.1%
Materials 12.3% 11.1% -0.9% -7.9%
Chemicals 30.1% 29.6% 30.2% 21.9%
Construction Materials -1.1% 3.5% -288.7% —
Containers & Packaging 7.7% 8.9% 1.6% -11.1%
Metals & Mining -13.8% -14.7% -47.9% -43.9%
Paper & Forest Products 3.6% 2.6% -34.8% -22.9%
Industrials 4.9% 2.4% 12.3% 0.8%
Aerospace & Defense 0.5% 0.4% 2.6% -14.2%
Building Products -0.9% 0.9% 100.0% 53.3%
Construction & Engineering 16.6% 16.8% 12.7% 22.4%
Energy is expected to see large drags in 3Q12. The YoY growth in earnings for 3Q12 is expected to be -15.1%. Top line is also expected to be -2.0% YoY. This makes sense considering how far oil prices have declined.
Figure 29: 2Q12 and 3Q12E YoY Revenue and Earnings Growth – Near-Cyclicals
2Q12 and 3Q12E YoY Revenue and Earnings Growth – Near-Cyclicals
Source: J.P. Morgan and FactSet.
Revenue Net Income
2Q12 vs.
2Q11
YoY %
chg
3Q12E
vs. 3Q11
YoY %
chg
2Q12 vs.
2Q11
YoY %
chg
3Q12E
vs. 3Q11
YoY %
chg
Near-Cyclicals 3.9% -5.2% 15.1% -3.4%
Energy 4.6% -2.0% -13.8% -15.1%
Energy Equipment & Serv ices 23.0% 18.6% 24.7% 6.0%
Oil Gas & Consumable Fuels 3.1% -3.9% -18.1% -17.9%
Twenty-nine companies have reported 3Q12 earnings so far. As shown in Figure 31, 3Q12 EPS beats are around 52%, which is slightly lower compared to the level of beats seen over the last 4 quarters. However, we are currently seeing stronger top-line beats for 3Q12, with revenue beats at 47%.
Figure 31: % of Companies Beating on Top Line and EPS
% of S&P 500 that has reported, beating on top line and EPS, 3Q12 based on 29 company reports
Source: J.P. Morgan and FactSet.
Figure 32: 3Q12 Sales Statistics So Far
Source: J.P. Morgan estimates and FactSet. Note: % beat for prior quarters is weighted. % beat for current quarter is median % beat.
59%
49%
62%
36%
47%
63% 61%69%
61%52%
0%10%20%
30%40%50%
60%70%80%
3Q11 4Q11 1Q12 2Q12 3Q12 3Q11 4Q11 1Q12 2Q12 3Q12
% c
os
bea
tin
g
Revenues EPS
% Up-/Down-side 3Q12 Sales % of cos beating estimates
Figure 36 through Figure 41 show various metrics for the 3Q12 reporting season at industry, sector, and index levels for the S&P 500.
The tables show the number of companies that belong to each industry and sector, as well as the market capitalization subtotals and the percentages of companies and market caps that have already reported. In these tables, we also provide information by industry and sector on the EPS growth achieved by those companies that have reported, the differential between actual and estimated revenue and EPS growth, and the expected growth for those companies that have yet to report. Moreover, these tablesprovide the percentage of companies that have beaten consensus estimates as well as the percentage that fell below expectations.
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financials Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financials Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financials Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Figure 39: S&P 500 – Top-Line and Net-Income Statistics for 3Q12E
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financial Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Reported EPS figures are available for 3Q12.
Net Income Sales
Quarterly Results Cont to Growth Quarterly Results Cont to Growth
Sector GICS Industry
Net
Income # Cos
% chg
yoy
% of
ending
Δ Net
Income
Δ NI /
Total Δ NI
% of
growth Sales # Cos
% chg
yoy
% of
ending Δ Sales
Δ Sales /
Total Δ
Sales
% of
growth
Energy 101010 Energy Equipment & Services — 0 — — — — — — 0 — — — — —
Figure 40: S&P 500 – Top-Line and Net-Income Statistics for 3Q12E (continued)
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financial Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Reported EPS figures are available for 3Q12.
Net Income Sales
Quarterly Results Cont to Growth Quarterly Results Cont to Growth
Figure 41: S&P 500 – Top-Line and Net-Income Statistics for 3Q12E (continued)
Source: FactSet and J.P. Morgan calculations. Note: The estimates may differ slightly from Thomson Financial Director Report's estimates due to methodology differences. Percentages correspond to those companies for which both a IBES Mean Estimate and
Reported EPS figures are available for 3Q12.
Net Income Sales
Quarterly Results Cont to Growth Quarterly Results Cont to Growth
This section of the report provides key metrics for each company belonging to the S&P 500. The S&P 500 companies are listed according to the industry in which they belong. For each company, we provide pricing information and market cap, theJ.P. Morgan rating if the company is covered, the year-to-date change in its consensus EPS estimate for 3Q12, and its history of upside and downside surprises within the last 18 quarters.
In addition, for those companies that have not reported yet, the tables show their expected reporting date, their IBES consensus EPS estimate, and the EPS reported in the previous year’s quarter. Similarly, for those companies that have reported, we show the actual EPS figures and whether, and by how much, they beat expectations.
Only 2 of 7 indicators at '07/’10/’11/early ’12 “peak” triggered. Remain constructive and favor high-beta Cyclicals. – 10/4/12
Weak 2H September Leads to Positive October; Focus on High-Beta Cyclicals: 47 Ideas– 9/27/12
2012 Beta chase expected to exceed 11%-15% seen ’09, ’10, ’11. 47 ideas – 9/19/12
Raising short-term target to 1495 (from 1475). Still cycle into Cyclicals. 27 ideas –9/13/12
Stay constructive on S&P 500… – 9/6/12
Global CC: Equity Markets Rally into Close Elections… – 9/4/12
Reasons to Say Constructive. HY and Positioning Data – 8/31/12
Raising Short-Term S&P 500 Target to 1475 by Early Nov. Maintain YE @ 1430. Cycle into Cyclicals Now. 12 Ideas – 8/17/12
US Fiscal Cliff: Election Outcomes Affect Policy Outcomes. 15% Chance of “Falling Off the Cliff” – 8/7/12
Surprising Upturn in Eco Surprise Indices Positive for Cyclicals – 8/3/12
Only 13% of Active Managers Outperforming, Worst YTD in 15 Years; Contrarian “Buy” Signals from Mutual Fund and HF Beta – 7/27/12
Corporates AGAIN Are the Incremental Buyer of Equities. Buybacks Soared in June to $67 Billion. – 7/23/12
See Energy Gaining in 2H; 14 Ideas – 7/20/12
2Q12 S&P 500 EPS: Poor Visibility + Pre-announce = NERVES: 2Q tracking to $26. $105 EPS on track…looks a lot like 4Q11 and 1Q12. Stay constructive and patient –7/13/12
6 reasons we would be buyers of the S&P at 1275-1325, despite weak June labor report… – 7/9/2012
Special Reports
MARKETING DECK: We See a “Melt-Up” Into Election Day: S&P 500 to EXCEED 1495 Short-Term…Market’s Base Case is Obama Victory – 9/20/12
SLIDES: Housing Food Chain IV: 10 Reasons We Are Early in Housing Up-Cycle, 18 ideas – 8/29/12
MARKETING DECK: The Case for a Secular Bull Market: Why we see equities as best relative value – 4/13/12
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Important Disclosures
Market Maker: JPMS makes a market in the stock of NiSource, Inc..
Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for NiSource, Inc. within the past 12 months.
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Date Rating Share Price ($)
Price Target ($)
06-Nov-06 UW 23.63 --
30-Jul-07 N 19.23 --
09-Feb-09 N 10.79 10.00
22-May-09 N 10.48 11.00
05-Aug-09 N 12.97 14.00
25-Jan-10 N 14.67 16.00
05-May-10 N 16.60 15.00
05-Aug-10 N 16.72 17.00
02-Feb-11 N 18.35 18.00
05-May-11 N 19.55 19.00
The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings or designations: OW = Overweight, N= Neutral, UW = Underweight, NR = Not Rated
0
10
20
30
40
Price($)
Oct06
Jul07
Apr08
Jan09
Oct09
Jul10
Apr11
NiSource, Inc. (NI, NI US) Price Chart
N $14 N $17 N $19
UW N N $10N $11 N $16N $15 N $18
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.
Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stock’s expected total return is compared to the expected total return of a benchmark country market index, not to those analysts’ coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analyst’s coverage universe can be found on J.P. Morgan’s research website, www.morganmarkets.com.
J.P. Morgan Equity Research Ratings Distribution, as of September 28, 2012
Overweight(buy)
Neutral(hold)
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