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VERSACE: Purchasing managers’ crystal ball

- - Thursday, June 14, 2012

ANALYSIS/OPINION:

To some, the end of this week means that July Fourth is right around the corner, but to investors, it means there are two weeks left in the current quarter and less than a month before publicly traded companies start reporting their second-quarter 2012 results. Over the next few weeks, we will be rolling up our sleeves and tabulating data, refining projections, looking at the change in input costs and more to determine whether companies will meet, beat or fall short of Wall Street forecasts for their second-quarter revenues and profits.

The reason for all of this math? For more than a few weeks now, we have seen indicator after indicator confirming slowing growth in the U.S., China and India, with Europe in a recession. In reviewing a number of key economic indicators - including nonfarm job creation, retail sales, durable goods orders and a number of purchasing managers indexes - that softness started to unfold in March and accelerated in April and May. This was particularly true for the eurozone and China in terms of their purchasing managers indexes.

For those unfamiliar with the purchasing managers index, it is an important sentiment indicator as it reflects survey results among purchasing managers across the country about their production levels, customer orders, supplier deliveries, inventories and employment levels. In short, the index is considered a leading indicator for national economies, particularly in the eyes of the Federal Reserve. Purchasing managers' data from Markit Economics shows the eurozone has been contracting since February, while similar data supplied by HSBC Markit reveals China's manufacturing has been slowing since January.

Government economic data are good sources of information, but as we have seen with the monthly employment reports, third-party data or commentary from companies can give an earlier read on what is going on and sometimes a better one. Recent results from McDonald's show that its sales in Europe and Asia cooled considerably in May. Tesco, the world's third-biggest retailer, reported a drop in underlying first-quarter British sales, and Carphone Warehouse warned that it expects the consumer environment in Europe to remain difficult as it forecast a decline in new sales because of weak demand for pay-as-you-go handsets.

On the cost side of the equation, raw materials and other inputs - oil, gas, corn, cotton, copper and coffee to name a few - have declined in recent months. This is one of the silver linings of the slowing global economy, but that same slowing will pressure the demand side of the equation.

The real question is whether companies will be able to once again "beat and raise" Wall Street expectations this earnings season. The consensus forecast for the S&P 500 calls for second-quarter earnings of $26.25 per share, up 7.6 percent from the first quarter and 8.7 percent higher than the last year's second quarter. Given the downward vector with the global economy during the current quarter, there is a growing belief that second-quarter corporate earnings will be messier than they have been in some time.

In a past column, I pointed out the disparity between the Wall Street consensus view that S&P 500 earnings would grow by 5 percent in 2012 - far slower than in the past two years - and the slowing earnings growth that tends to go hand in hand with multiple contractions. In other words, it is hard to see investors paying much beyond the current market multiple of 13.4 for the S&P 500 near term when the market last year peaked at 13.9 times the earnings per share.

Heading into the second half of the year, investors will look for companies positioned to grow faster than the overall economy that are poised to grow earnings faster than the S&P 500. As I discuss in PowerTrend Profits, near term I continue to favor guilty-pleasure stocks and stocks with favorable dividend yields.

Chris Versace is editor of the PowerTrend Brief and PowerTrend Profits newsletters. Visit them at ChrisVersace.com, or follow him on Twitter @_chrisversace. At the time of publication, Mr. Versace had no positions in companies mentioned; however, positions can change.