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Rising S&P revenue heralds good news for markets

by Community Manager

‎07-30-2014 12:54 PM

market commentaryBy John Toohey, head of equities

 

This week we pass the midway point of the second-quarter earnings season for the Standard & Poor’s 500 index. What we’ve seen so far has been quite good in terms of both revenue growth and earnings growth.

 

Revenue growth has been around 3.5 percent for the companies that have reported so far. That figure jumps up to nearly 6 percent and earnings growth comes in about 11 percent if you don’t count the financial sector. Guidance by companies yet to report indicates that the numbers may slip a bit, but we still may be on track for the best quarter for combined revenue and earnings growth (ex-financials) in more than two years.

 

And that good news is being shared across the market. Of the S&P 500’s 10 sectors, only energy is seeing a drop in revenue compared to the same period last year, according to data from FactSet Research, while only the financials are reporting lower year-over-year profits. About two-thirds of companies are beating their revenue estimates for the quarter, FactSet reports, and even more are surpassing per-share earnings forecasts.

 

We’ve been waiting for some time to see revenue growth pick up. For several years now, companies have been improving their profitability primarily by focusing on the expense side of the ledger: cutting operating costs, refinancing their debt at lower interest rates, buying back stock, and engaging in mergers and acquisitions. Over time, however, these short-term tactics lose their effectiveness. A company cannot grow its business over the long haul without growing its revenue.

 

The federal government reported this morning that U.S. GDP grew by 4 percent in the second quarter, which was much better than the 3 percent growth expectation. What we’re seeing in the second quarter’s earnings numbers could be just a predictable snapback from the disastrous first quarter, during which the U.S. economy shriveled up in the cold weather. Or it could be another positive indicator that the economy is getting healthier and better business conditions lie ahead.

 

At this point, because we tend to think defensively as investors, we are discounting the quarterly numbers a bit until we know more about the sustainability of revenue and earnings growth. We are currently underweight U.S. equities compared to our asset-allocation benchmarks due to valuation concerns. If it looks like we’re heading into a period of steady economic growth and reliably rising revenue, current valuations may be more justifiable than they now appear.

 

One way we’ll be monitoring the economy going forward will be through a new government statistic known as “gross output.” We believe gross output may give us a broader measure of overall economic activity than that provided by GDP, which is defined as the total value of final goods and services produced.

 

The focus on finished products skews GDP heavily toward being a gauge of consumer spending — in fact, consumption accounts for roughly 70 percent of U.S. GDP. But the process of getting from raw material to finished product can require many stages, with economic value being added each intermediate stage. Gross output captures this and other activity, including capital investment to expand production.

 

We’re certainly not arguing that GDP is not a valuable statistic, but because of its emphasis on final goods and services, it may not be the best real-time indicator of economic activity. When the economy shrinks, capital investment tends to shrink faster than consumption. Conversely, when the economy is growing, investment would be expected to expand more than consumption. Gross output may prove to be an effective addition to our tool kit for measuring economic growth.  

 

USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are no longer cheap, and profit margins are near record highs.

 

 

We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate-Term Bond Fund and the USAA High Income Fund fit this profile.

 

We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.

 

We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. 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 your individual goals, objectives, risk tolerance and time horizon.

 

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

 

Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.

 

Investing in securities products involves risk, including possible loss of principal.

 

Past performance is no guarantee of future results.

 

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

 

As interest rates rise, existing bond prices fall.

 

Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities.

 

Some income may be subject to state or local taxes or the federal alternative minimum tax.

 

Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.

 

The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.

 

Standard & Poor’s 500 Index and S&P are registered trademarks.  The S&P 500 Index is an unmanaged index of 500 stocks.  The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market.  S&P 500 is a trademark of the McGraw-Hill Companies, Inc.

 

USAA Managed Portfolios-UMP™ is a service of USAA Investment Management Company, a registered investment adviser and broker dealer.

 

Financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License # 0E36312), and USAA Financial Advisors, Inc., a registered broker dealer.

 

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

 

The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.

 

Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.

 

An investor will indirectly bear fees and expenses charged by the underlying funds in addition to direct fees and expenses charged by the portfolio as applicable. 

 

Diversification does not guarantee a profit or prevent a loss.

 

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Briana Hartzell

Briana Hartzell

Briana knows all about moving. This Navy spouse has helped her husband relocate to four different naval air stations in the last three years. A former USAA employee, Briana writes at Being Briana, a blog focused on the joys military life can bring.

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Charles Pratt

Charles "Chazz" Pratt

Charles "Chazz" Pratt III is a former U.S. Army Captain who made the Military-to-Civilian career transition in 1994. In his book, The Fort Living Room Transition Course, he shares valuable tips & tricks to help you succeed. Since his transition from the military, he's worked for several Fortune 500 companies, including Pfizer, Genentech, and St. Jude Medical, among others.

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Joseph "J.J." Montanaro

Joseph "J.J." Montanaro is a CERTIFIED FINANCIAL PLANNER™ practitioner.

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