The Real Cliff: Earnings

Predictably, today's stock market was quiet, with the Dow Jones Industrial Average (INDEX: ^DJI  ) and the broader S&P 500 (INDEX: ^GSPC  ) gaining 0.4% and 0.2%, respectively.

The macro view: It's not unreasonable to think that the fiscal cliff will be one of the major drivers of stock returns, if not the major one, between now and the end of the year (or whenever it is resolved!). Over longer periods, however, earnings ultimately drive stock prices, and with 98% of companies having reported their results for the third quarter, I thought it might be useful to make a few remarks on the numbers:

  • At $24.37, quarterly earnings for the S&P 500 fell 3.6% year on year, the first decline since the third quarter of 2009.
  • Since the end of September, the earnings estimates for the S&P 500 for the fourth quarter has fallen 4.1%.
  • During the same period, the 2013 earnings estimate for the S&P 500 fell only 1.3% to $113.45 (fewer companies offered guidance for next year than for the next quarter). To achieve this, the S&P 500 will need to achieve nearly 14% earnings growth year on year.

Next year's implied earnings growth target of 14% looks like a very tall order: Profit margins are at historically high levels, and year-on-year growth of S&P 500 trailing-12-month earnings has been decelerating since the third quarter of 2010, falling to 3.3% in the last quarter.

The micro view: Between the guilty verdict rendered against UBS rogue trader Kweku Adoboli – the biggest fraud cause in U.K. history -- and the arrest of a portfolio manager at prominent hedge fund SAC Capital on charges of insider trading, yesterday was a big reminder that poorly constructed, short-term financial incentives encourage bad behavior. While the financial industry has made improvements in tackling bad incentives for traders, it's one of the reasons one of our analysts called Wells Fargo (NYSE: WFC  ) "the only big bank built to last." Click here to request our premium report to get a full assessment of this opportunity, and 12 months of ongoing coverage.


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