03 February 2012 at 10:38 GMT
US earnings season beats estimates by 3%
With 44 percent of the S&P 500 companies having reported we are getting closer to a sample size that is closer to where earnings eventually will end up. The overall surprise is currently three percent as in the previous two quarters (see chart below) signalling that companies are still able to surprise analysts.
The chart also illustrates that consensus EPS estimates the next two calendar quarters point to a decline in the first before rebounding into growth mode again in the second.
S&P 500 could see 1,370 level if economic data continues to surprise
Following the escalation of the European debt crisis back in August 2011 forward valuation in the S&P 500 tumbled to levels not seen since late 2008 and early 2009 (see chart below). Blood was readily running through the streets and investors discounted a new painful recession and as a result confidence hit the floor. Slowly economic data turned to the better and Citigroup's US economic surprise index has been rising rapidly reflecting much better economic data than expected.
With better US economic data defying the crisis in Europe, the introduction of the global USD swap agreement in early December and Long-term Refinancing Operation (LTRO) programme in early January, confidence in the economy and risk assets returned. Thus the S&P 500 is now trading at 12.6 times next 12 months' EPS, still below historical levels. If sentiment about the future recovers to the levels before Europe's crisis began then the S&P 500 could propel to around 1,370, about 3.5 percent from current levels.
On a risk-reward basis the downside risk is definitely rising as a renewed deterioration in economic data or confidence could easily send the S&P 500 down to 11.5 times next 12 months' EPS or 1,210 in index terms or a decline of 8.6 percent.