The Future Ain't What It Used To Be
Analyst expectations for top line growth in the back half of 2013 continue to fade, and worries over a looming “Revenue recession” grow commensurately. As ConvergEx's Nick Colas notes, the first quarter of 2013 posted an average negative 0.6% revenue comparison for the 30 companies of the Dow Jones Industrial Average, and Q2 (with a few companies left to report) looks to be +0.3%. But back out the financials, and he points out that the number goes negative to the tune of (0.3%). Analysts are still chopping away at their back half expectations, now down to 1.9% for Q3 and 2.1% for Q4 2013. Those are down from 4-5% expected comps back in March, so the trend is still clearly not our friend. As we have pointed out previously, equity markets have been powered by multiple expansion year-to-date, but, as Colas asks (rhetorically) do you really want to pay up at this point in the business cycle for still declining expectations?
Via ConvergEx's Nick Colas,
If human nature has one constant, it is the near-universal desire to know the future. The ancient Greeks, for example, had their oracle of Delphi - an older woman who sat in a room full of fumes from an underground volcanic fissure and gave at-best-nebulous commentary about forthcoming events. Europeans have their gypsies – really called “Romani” – who will tell your fortune after the appropriate amount of gold crosses their palms. And even though it is technically illegal here in Gotham, New Yorkers have access to thousands of storefront and sidewalk seers. Some even have reviews and sponsored ads on Yelp.
Wall Street is pretty big on fortune telling itself, of course. The tools of the trade are spreadsheets rather than crystal balls, even if the predictions occasionally have a Delphic twist (‘A great company will fall this year…’). Equity analysts forecast a whole range of financial outcomes – revenues, earnings, profit margins, and the like – not to mention stock price targets. Take as a group their prognostications become the market’s best guess at the future, essentially a crowdsourced band of financial gypsies promising health or illness, feast or famine. If there is a predictable cadence to these efforts, it is that analysts tend to start the year optimistic for the future, only to perennially lower their aspirations as the months progress.
Such is the case for revenue expectations as we meander through 2013. We’ve been focused on this particular financial metric since 2010, rather than the more typical Street fixation with earnings. The reason for this is simple: it hasn’t been hard to find earnings growth in corporate America. Profit margins, as S&P continually notes in their work on corporate earnings, are within basis points of cyclical highs. No – it is revenue growth that has gone missing since the nominal end of the Great Recession. And no, this hasn’t hurt equity values overly much, with the S&P 500 still hovering close to 1700. Record corporate earnings deserve some recognition, after all.
At the same time, there’s also no doubt that revenue growth is the real gas-down-the-carburetor that gets equity investors enthusiastic about stocks rather than just viewing them as the least-bad investment alternative in their basket. By that count, the current year is proving disappointing. Consider the following:
Revenue growth in Q1 2013 for the 30 companies of the Dow Jones Industrial Average was negative 0.6%. We look at this old-school index for a few reasons, but chief among these is the generally “Better-to-best in class” nature of the companies in the Average. When these companies, with the advantages of scale and scope, can’t post top line growth, you know things are slow around the world. (See attachment for various tables and charts.)
With just a few companies left to report their Q2 2013 financial results, the average Dow company’s revenue growth is just 0.3% for the second quarter. Back out the financials and that result drops to (0.3%).
Last month we warned that corporate America was facing something of a ‘Revenue Recession’ and the data from this month’s analysis of analysts’ financial models finds that Wall Street is moving towards our point of view. Their average expected Dow Industrials revenue growth for Q3 2013 is down to 1.9%, and Q4 2013 is now reduced to 2.1%. Those estimates were 4-5% year-on-year just back in March, with every month since then seeing analysts cutting their expected top-line growth closer and closer to the breakeven point.
Looking farther into the future, Q1 2014 expectations are now for 3.3 – 3.7%. As you might expect, however, these numbers are lower than the +4% analysts were showing their clients just two months ago.
You might be humming a little Talking Heads at the moment and murmuring, ‘Same as it ever was…’ Analysts always start high and end low, right? Well, yes and no.
Back in 2009/2010, our data shows that they did in fact increase revenue and earnings estimates as the U.S. economy bottomed. Once things stabilized, however, they went back to the normal pattern of an optimistic January and a blighted December. At least you know it isn’t the weather that alters their moods…
The upshot of this analysis as we wobble around S&P 500 levels of 1,700 (give or take) has more to do with valuation and momentum than anything else. Analysts have gotten revenue growth numbers wrong for three years and the U.S. equity markets have been up – dramatically. Why should it matter now? Three final points:
Valuation levels on U.S. stocks based on 2013 earnings – call that $110 on the S&P 500 – are no longer “Cheap”. Current levels imply a 15x multiple and that is perfectly reasonable for a normal market. But with the potential diminution of Federal Reserve bond buying in the wings for Q42 2013, not to mention incremental sequestration from the fiscal side of Washington, things feel more ‘Contractionary’ than “normal.” If you shouldn’t fight the Fed, why are you going to take on the Congress as well?
U.S. stocks are looking for positive ‘Old school’ catalysts to move markets higher. We do have some of those in the form of ‘Bread’ (corporate buybacks) and ‘circuses’ (activist investors with a penchant for social media). But we are missing others, most notably corporate M&A. And, as we are highlighting in this note, increasing confidence in accelerating revenue growth.
One of the most powerful arguments to own U.S. stocks in 2013 has been the somewhat rhetorical query: “Where else you going to go?” Frankly, to me that sounds more like the response of a tired spouse being threatened with divorce at the end of an evening’s quarrel than a well-considered investment thesis. It might work as a reason to stay married – or invested – for a short time. But not for the long haul.
I think it was Woody Allen who once said, “A relationship, I think, is like a shark. It has to constantly move forward or it dies. And I think what we got on our hands is a dead shark.” If you are bullish on U.S. stocks at these levels and with these revenue fundamentals, you will be rooting for the shark to start moving. Soon.