The S&P earnings growth for Q4 has turned negative. S&P Q4 earnings have come down to $27.77 which is down -1.7% from $28.25 in Q4 2013. Estimates for Q1 and Q2 2015 have also continued their decent. Q1 earnings growth is estimated down -1.2% and Q2 down -0.3%. Q3 2015 earnings estimates have started coming down as well. Earnings growth in Q3 is now only expected to be up +3.1%.
After the S&P rallied 3.0% mtd and earnings estimates have decreased, the forward pe of the S&P has increased to 17.3x. This is far above the 5-year and 10-year averages of 13.5x and 13.8x. The current valuation is even stretched relative to the long-term 25-year average of 15.6x. The high valuation of the S&P leaves little margin for support if earnings weaken further.
The energy sector has had the largest earnings drop over the past 6 months.
The price of oil may have bottomed, which may signal the downward revisions of earnings estimates in the energy sector may finally come to an end.
So maybe the energy bottom is finally in, we'll have to wait and see. I don't think its wise to be underweight energy at this point. The energy sector will remain volatile, but I think it is safe to buy the high quality names. My preferred energy stocks are FTI and HAL. The earnings estimates better increase in the energy sector because the forward pe is currently 28.3x. This is obviously an unsustainable level. Something has to give; either the earnings come back up or the energy stocks will decrease.
The S&P is expected to grow earnings 4.2% in 2015, contracting in the first half and picking up in the second half. This is the slowest growth in earnings since the Q4 2011 to Q3 2012. The major difference is valuation. During 2011 -2012 the S&P had a forward pe ratio in the 11x - 13x area. Today with such a high valuation, the low level of earnings growth could trigger a market correction.
After energy, what sectors have the weakest earnings growth expectations for 2015 versus 2014: utilities +1.4%, staples +2.9%, and financials +3.7%. What sectors have the highest 2015 earnings growth expectations: health care +23.3%, tech +16.4%, materials +9.4%, discretionary +8.3%, and industrials +8.2%.
How about valuation:
The most attractive sectors relative to valuation and earnings growth are health care and tech. Most other sectors are over-valued with little earnings growth. Dividend yield might not be a support this year with the Fed hikes on the way. The utilities, telecom, and staples sectors which draw much of their price support from dividend yield may become far more dangerous as rate hikes approach than they were last year when bonds rallied. Friday's bond and dividend stock selloff showed there might not be many safe places to hide this year.
Michael Grove, CFA