In the US, we are about half way through the first quarter 2013 earnings season. So far, companies in the S&P500 have reported sales 1% below consensus estimates (flat YoY in absolute terms) and earnings per share (EPS) 5% higher than market expectations (up 2% YoY). Since stock markets are priced at the margin, the comparison against expected earnings tends to drive short term stock performance. The collective higher than expected earnings per share (EPS) has helped the S&P500 rally in the face of weaker than expected US macro data in the past week.

The top performing sectors have been Consumer Discretionary, Energy and Materials. The more cyclical sectors have arguably done better as expectations have been subdued going into reporting. On the other hand, Health Care, Consumer Staples and Utilities, that have been the leaders in price gains this year, have lagged during this period.

Notwithstanding the positive earnings surprise for the market as a whole, we note the 5% margin by which companies exceeded estimates is only on par with historical trends over the past 8 quarters. Moreover, company top lines continue to be uninspiring, in both relative to estimate and absolute terms, which leaves cost management and share buy back as the main avenues to boost margins and earnings. The fear is that there is a limit to cost and efficiency gains, although share repurchases may be sustained for companies with strong cash flows and balance sheets. As companies buy back shares, EPS should rise, all else being equal.

Furthermore, US equities have benefited from a net inflow of funds in 2013, which has arguably diluted the impact of stock fundamentals on price performance. Global investors are faced with very low returns on cash and are therefore allocating more to riskier assets. This technical factor is significant and is something we monitor as our investment philosophy combines both fundamental and macro views.

Felix Fok

Portolio Manager, Global Equities