02-14-2014 10:38 AM
By John Toohey,
Vice President, Equity Investments
As of this week, more than 70% of the companies in the Standard & Poor’s 500 have reported earnings for the latest quarter, revealing a few trends that create some concern about U.S. equities in 2014.
Excluding financial companies, earnings in the fourth quarter grew about 6.5% compared to the same three months in 2012, with an acceleration coming in the second half of 2013. Revenue growth, however, is well short of earnings growth and has shown no signs yet of picking up. Year-over-year revenue increases (ex-financials) for the December quarter were only around 3%. When financial companies are included in the calculation, the disparity between S&P 500 earnings growth and revenue growth is even greater.
This tells us that companies are still relying heavily on cost-cutting and share repurchases to lift per-share earnings. We have no philosophical argument with management teams that seek to wring greater efficiencies out of their businesses or to return capital to shareholders via buybacks, but both of these approaches have limits. Costs can only be cut so far before affecting operations, and current valuations make share repurchases an expensive and increasingly risky proposition.
Companies, on average, are providing forward guidance that they expect earnings growth to be positive in the March quarter, but to decline from the previous quarter. For all of 2014, companies foresee flat earnings growth, which is starting to worry investors that current valuations may be too rich.
As long-term investors, we believe higher-quality, bottom-line growth starts at the top line with revenue growth. Profit margins are already running high, and price-to-earnings multiples are stretched well beyond their historical average. In our view, revenue growth that drives earnings growth is key for the stock market to continue powering ahead.
Many consumer staples and consumer discretionary companies have yet to report their earnings for the December quarter. U.S. consumers account for 70% of the country’s GDP, so more spending at the household level could boost revenue. The trend since the second half of 2013 has been improving for the consumer — a stronger job market, reduced consumer debt and easier lending standards by banks. But the past two monthly jobs reports have been weak, and January retail sales announced this week lagged expectations.
Inclement weather is being blamed for the recent soft numbers, and that could be true. We’ll be watching to see whether the positive trend continues when the weather is no longer a factor. This would give us real insight into whether the consumer is feeling wealthier and thus more willing to generate economic activity by spending more.
The government’s statistics indicate that the economy is getting better, but this view is largely derived from a series of surveys. Company revenue — and more importantly, growth in that revenue — is a more tangible measure and one that would give us a higher degree of confidence in economic conditions as we move deeper into 2014.
For more on what we see ahead for investors this year, we invite you to read our 2014 investment outlook.
USAA Investments Managed Portfolio Outlook
Our view of caution toward U.S. equities remains unchanged. We remain slightly overweight cash in our diversified managed portfolios. For investors interested in income-oriented bond investments, the USAA Intermediate-Term Bond Fund, the USAA High Income Fund and the USAA Income Fund are examples. For investors interested in tax-free income, the USAA Tax Exempt Long-Term Fund, the USAA Tax Exempt Intermediate-Term Fund and the USAA Tax Exempt Short-Term Fund are examples.
We also are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund also provides potential protection against the risks of long-term inflation.
Emerging markets represent another opportunity. Though they were hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.
As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for you based upon your individual goals, objectives, risk tolerance and time horizon.
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