U.S. EquityStrategySeptember 14, 2012Page 3
2013 Earnings Forecast
With that said, we are introducing our 2013 S&P 500 earnings forecast of $102.25, which if realized, would represent asignificant slowdown in corporate profit growth next year. Based on our estimates, profit growth would slow to 3.3% in2013, compared to 7.1% expected for 2012, and the 15.2% growth seen in 2011 (Exhibit 2). The bottom-up consensusestimate for 2013 stands at $115.43 (11.7% Y/Y growth), but we believe the current consensus estimate is too high, andis likely to be revised lower in the coming months. Our more conservative forecast is based on the following assumptions:
Our primary earnings model is based on a macroeconomic regression model, in which we assume a below-trend GDP growth rate of 2% for 2013.
Given our continued low-growth expectations for 2013, we expect top-line revenue growth for the S&P 500 toslow to 3%, from the expected 5% growth in 2012.
Net income profit margins, which should remain healthy, could decline in 2013. Based on the currentestimate for 2013, sell-side analysts project net income profit margins to expand from the current 9.25%, to10.25% in 2013. As seen in Exhibit 2, current profit margins appear unsustainable in the 9-9.5% range, whichis well above the 7.7% average seen since 1998. With profit margins currently near-record levels, we fail tosee how they could expand further, and as such, incorporate a small margin contraction in our 2013 EPSforecast. However, it is important to note that significant margin compression is unlikely to occur until we seea large uptick in employment and wages, as employee compensation accounts for roughly two-thirds of thetotal production costs.With our belief that the earnings cycle is beginning to mature and could peak in 2013, we updated our normalizedearnings model, to see what it is forecasting for 2013. Normalized earnings help to smooth out earnings, by adjusting for the cyclical ups and downs, over the business cycle. We use an 8-year period to normalize earnings, as it averagesgrowth adjusted earnings over roughly two business cycles. Based on this model, we project normalized earnings in 2013at $99.54, which is 2.5% below our base case 2013 EPS forecast. All told, our EPS models point to continued healthyearnings in 2013, however we believe earnings will come in below the current optimistic consensus estimates, and thatU.S. earnings could peak in 2013. If correct, further upside in equity prices will have to be driven by continued P/Eexpansion, as the support of higher earnings growth begins to wane.
Exhibit 2: Weaker Profit Margins In Part Explain our More Conservative S&P 500 2013 EPS Forecast
S&P 500 Earnings Forecasts20112012E2013E
Economic Regression Model $96.54$99.00$102.25Y/Y Growth 15.2%2.5%3.3%Normalized Earnings Model $96.54$98.35$99.54Y/Y Growth 15.2%1.9%1.2%Bottom Up Consensus $96.54$103.38$115.43Y/Y Growth 15.2%7.1%11.7%
Source: Portfolio Advice & Investment Research. As of September 12, 2012
S&P 500 Net Profit Margin
Source: Bloomberg Finance L.P. As of September 12, 2012
7.7% is the average since 1998
Net profit margins areunsustainably high at 9.25%.