Growth Train Is Slowing

 | Oct 10, 2011 | 11:00 AM EDT
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While headlines over the past few months suggest that Europe's financial crisis is to blame for the U.S. stock market selloff, the focus is mainly on the fear that growth will again stall.

So far, growth is indeed slowing down. The expectation is that earnings per share (EPS) for the S&P 500, excluding financials, grew by 14% in the third quarter. This compares with 19% growth in 2011 second quarter and 20% in the first quarter, according to Bloomberg analysts' estimates. Looking ahead, analysts are expecting 12% growth, excluding financials for the fourth quarter. Of course, excluding financials is merely an attempt to whitewash the growth scenario. Over the past 30 years, the U.S. economy has shifted from industrials to a financial products and services; at the peak of the 21st Century bubble, financials represented nearly 40% of S&P earnings.

To be sure, going from 20% growth to 12% growth is still a recovery; the concern is that it was mere stimulus that caused growth to shoot up. Now that that's gone and the economy is left on its own, the fear is that the train is coming to a slow halt. As of last week, 174 out of 436 companies that had provided guidance had lowered third quarter earnings expectations, while 59 companies had raised expectations. Tomorrow after the market closes, aluminum giant Alcoa (AA) will once again kick off earnings season.

Of course, one company's better- or worse-than-expected results won't tell the story. But what the market does from here will be a story of earnings and future outlooks. Financials are again expected to have a weak quarter, but titans like Wells Fargo (WFC) and JP Morgan (JPM) can provide constructive future expectations. The bigger the company and the wider its reach on the U.S. consumer, the more insight the market will get.

At the same time, some smaller businesses are expected to thrive and announce solid results now and in the future. It's no surprise that these companies have vastly outperformed the market, not only during the selloff but also over the past year. Solid growth allows the price-to-earnings (P/E) multiple to remain as it or expand; both of which cause the share price to increase along with EPS growth. Expect to see that from $13 billion retail chain Dollar General (DG), which is expected to show sales and EPS growth of 11% and 20% quarter over quarter, but more importantly, a favorable outlook for 2012. Advance Auto Parts (AAP) will likely continue to benefit from the company's focus on the higher growth commercial "do it for me" sector along with an aggressive share buyback program. Sales and EPS growth will likely meet or beat expectations.

Agriculture equipment business AGCO (AGCO) earned a favorable review from Barron's this week due to the strong long-term fundamental outlook of agricultural related stocks. Despite that, shares have sold off along with the rest of the industry. In the past few weeks, the company has made some acquisitions, which the market may see as buying at the top. Shares are now trading for $35 down from $60 a few weeks ago. Its third-quarter sales are expected to rise by more than 20%, with EPS growth of 15%. This compares with a current P/E multiple of 9. When Deere (DE) announces results in late November, a favorable outlook would bode well for the industry as valuations are depressed. Deere now trades for 9x forward earnings and yields 2.5%.

Daily market gyrations are being influenced by what news comes out of Europe. Investors looking to act based on fundamentals and valuations are going to have to stop spending time on what type of resolution will come out of the European Union (EU) and instead on what corporate profits are telling us about the future of the economy.

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