lookout report - s&p dow jones indices...2012/10/26 · fourth-quarter 2011 24.46 first-quarter...

The U.S. Fiscal Cliff Threatens Confidence, And Future S&P 500Earnings

Just over one dozen senior-level executives, representing a diverse cross-section of U.S. financial

sector corporations and industries, took the highly unusual step of publicly urging the President

and Congress to put partisanship aside and take "concrete steps to restore the U.S.' long-term

fiscal footing." While the looming "fiscal cliff" has been a topic of grave concern for investors

since the start of the year, the market has mostly taken its cues from other issues, e.g., the

European sovereign debt crisis, the prospect of additional nonconventional monetary stimulus

from the Fed (i.e., QE3), and the risk the U.S. economy could join Europe in recession.

The Global Markets Intelligence (GMI) research team believes an unusual lack of clarity is

currently associated with the threats tied to the fiscal cliff, leaving investors with the conclusion

that the combined negative effects of substantial tax increases and mandated federal spending

cuts are so detrimental to the fragile economy that Congress will have little choice but to first

delay the occurrence, then never let it happen in the first place. The Oct. 18 letter from the

Financial Services Forum addresses a very serious concern, which these executives summarize as

the "consequences of inaction." We agree with this sentiment wholeheartedly, in that extremely

elevated levels of business and consumer uncertainty--evident throughout this business cycle in

terms of slow job creation, cautious credit extension by banks, and consumers' reluctance to

purchase homes and automobiles--could become even more tentative if lawmakers delay, or

worse, avoid addressing existing fiscal challenges.

We believe the close ties between confidence, the economy, and financial markets are very real.

The 15% year-to-date rise in the S&P 500 Index mostly has been in anticipation of healthier

future economic and corporate earnings growth both in the U.S. and abroad. The pledge from

ECB President Draghi to do "whatever it takes to preserve the euro," along with the Federal

Reserve's efforts to invigorate the nascent U.S. housing market recovery as a path to lowering

unemployment, have done more to push stocks higher this year than either reported

second-quarter or expected third-quarter S&P 500 earnings. From this perspective, 2012 stock

market performance can be seen as a leap-of-faith anticipation rally as opposed to a

fundamental earnings-driven rally.

For S&P 500 earnings specifically, the stage is set for either a business/consumer-confidence-led

Lookout Reportfrom Global Markets Intelligence

October 26, 2012

Michael G Thompson

Managing Director

Global Markets Intelligence

(1) 212-438-3480

[email protected]

Robert A Keiser

Vice President


(1) 212-438-3540

[email protected]

The Lookout Report is a compendium

of current data and perspectives from

across S&P Capital IQ and S&P

Indices covering corporate earnings,

market and credit risks, capital

markets activity, index investing, and

proprietary data and analytics.

Published bi-weekly by the Global

Markets Intelligence research group,

the Lookout Report offers a detailed

cross-market and cross-asset view of

investment conditions, risks, and

opportunities.

1031028 | 301128617

recovery in earnings resulting in additional stock market appreciation, or a continued subpar confidence/economic

environment where future earnings expectations do not materialize, or at minimum, are revised sharply lower over time as

has been seen for well over a year now. Expected calendar-year 2012 S&P 500 earnings have declined precipitously, to a

low of $102.86 on Oct. 1 from the peak of $113.41 on July 29, 2011.

Reflecting existing subpar macroeconomic conditions, reported quarterly S&P 500 earnings mostly remained unchanged,

at around $25.50 per share for the past six quarters since the second quarter of 2011 (including the current third-quarter

reporting season, see table 1). S&P 500 earnings are expected to finally break to the upside in the final quarter of 2012,

and continue setting additional records for quarterly earnings in 2013, according to the S&P Capital IQ consensus; but

this only will happen if the U.S. avoids the fiscal cliff, avoids joining Europe in recession, and consumer and business

confidence improves in line with global central bank intentions.

In our opinion, the extent to which reported third-quarter earnings can be relied upon to foreshadow healthier future

earnings must now be weighed in consideration of the ability of the U.S. to demonstrate that it "is a democracy capable of

putting differences aside to solve our most challenging problems" (per the July 18, 2011, letter from the Financial Services

Forum during the U.S. debt ceiling impasse in Congress).

Table 1

S&P 500 Reported And Expected Quarterly Earnings Per Share, $

First-quarter 2011 23.63

Second-quarter 2011 25.46

Third-quarter 2011 25.42

Fourth-quarter 2011 24.46

First-quarter 2012 25.39

Second-quarter 2012 25.69

Third-quarter 2012* 25.73

Fourth-quarter 2012* 26.54

*S&P Capital IQ consensus, blended mean (reported results and analyst expectations).

Inside This Issue:

Macroeconomic Overview

While the looming "fiscal cliff" has been a topic of grave concern for investors since the start of the year, the market has

mostly taken its cues from other issues, e.g., the European sovereign debt crisis, the prospect of additional

nonconventional monetary stimulus from the Fed (i.e., QE3), and the risk the U.S. economy could join Europe in

recession.

Economic And Market Outlook: North American And European Earnings

More than one-half of S&P 500 companies have released third-quarter earnings results at this point, and positive surprises

have boosted overall profit growth to 1.14%. While this is the highest growth expectation for the third quarter since July

20 (1.16%), it still marks the lowest earnings growth rate for the S&P 500 in three years.

International Update: A Sound Policy Climate And A Stable Political Regime Underpin Turkish Shares

A languishing economic expansion and a menacing border skirmish would ordinarily render a national stock market

unworthy of an accentuated portfolio exposure, but--in the case of Turkey--unassailably sound official policies, fortified

The U.S. Fiscal Cliff Threatens Confidence, And Future S&P 500 Earnings Lookout Report from Global Markets Intelligence

2 October 26, 2012

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by stable internal politics, entitle the Istanbul Stock Exchange (XU100) to a still-solid emerging equity market holding,

pending forthcoming developments in business activity.

S&P Index Commentary: Fourth-Quarter Estimates Reflect A Disconnect

Although third-quarter actual earnings have painted a disappointing picture (especially because they were lowered

continuously before earnings season began), they have not been devastating: 62.9% of companies beat the S&P Capital IQ

consensus estimates, compared with the historical average of 62%.

Leveraged Commentary And Data: The Sharpe Ratio Of S&P/LSTA Index Hits A 57-Month High

After plunging in the aftermath of the 2008 crash, the risk/return profile of leveraged loans--as measured by the Sharpe

ratio of the S&P/LSTA Leveraged Loan Index--has been on the comeback trail as a result of rising loan returns and ebbing

volatility.

R2P Corporate Bond Monitor

After a flurry of accommodative monetary policy measures at the last meeting in early September, market analysts expect

the Federal Open Markets Committee to maintain the status quo. The Fed vowed last month to keep interest rates below

0.25%, with $40 billion per month of new stimulus, until unemployment recovers. With the Fed taking unprecedented

steps to support growth, American companies remain better positioned relative to their European peers amid concern

about unemployment and manufacturing growth.

Municipal Bond Commentary: The Riskiest Municipal Bonds Are Pulling Up The High-Yield Market

Municipal bond funds have seen steady cash inflows, maintaining the demand/supply imbalance and continuing to hold

yields down. High-yield municipal bonds, as tracked by the S&P Municipal Bond High Yield index, keep inching upward,

outpacing the general market and helping boost the index's total return of 15.36% year to date.

Fixed-Income Commentary: International Bonds Offer Portfolio Diversity

U.S. investor sentiment was bearish at 44.55% last week, according to the American Association of Individual Investors

(AAII) Sentiment Survey. This weekly survey of its members asks if they are bullish, bearish, or neutral on the stock

market over the next six months. Although not as high as the 56.72% reached in February 2009, this is still a strong

sentiment when coupled with 26.8% neutrality.

Market Derived Signal Commentary: Weak Earnings And Bleak Outlook Send IT Premiums Higher

From Sept. 14 through Oct. 19, 2012, the S&P 500 Index has given back 2.22%, and information technology has been

largely to blame, declining 7.8% over the period. According to Global Markets Intelligence Research's colleagues at S&P

Dow Jones Indices, the S&P 500 Index would have lost 0.96% if technology was excluded. Technology issues accounted

for 12 of the 25 stocks with the most significant declines.

Capital Market Commentary: U.S. IPOs Priced In 2012

The recent announcement by Facebook Inc. that its third-quarter financial results exceeded analysts' consensus

expectation perhaps should come as little surprise. From the perspective of recently completed initial public offerings,

more often than not, earnings results have managed to come in above the expectations of Wall Street. Of the 36

U.S.-based IPOs that reported first-quarter 2012 earnings, 56% beat analysts' forecasts.


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S&P Index Commodity Commentary: Industrial Metals Lead October Declines

Commodities have declined in October with other risk assets, because of global economic concerns. Industrial metals led

the losses in the S&P GSCI, but declining energy prices had the largest index impact. Increasing energy production

(notably in North America) pressured energy prices, offering some hope that the potential for macroeconomic benefits

from cheaper energy costs will eventually prevail.

Economic And Market Outlook: North American And European Earnings

North America

More than one-half of S&P 500 Index companies have released third-quarter earnings results at this point, and positive

surprises have boosted overall profit growth to 1.14%. While this is the highest growth expectation for the third quarter

since July 20 (1.16%), it still marks the lowest earnings growth rate for the S&P 500 in three years.

While third-quarter earnings results are coming in higher than expected, investors seem to have been spooked by some of

the grim forward-looking guidance released by corporations. This was apparent on Tuesday when investors took the S&P

500 to its lowest level since September, after cautionary earnings reports were released from three main Dow Industrial

components: DuPont (E.I.) De Nemours & Co., 3M Co., and United Technologies Corp. All three companies provided

negative outlooks for the coming quarters, with Dupont announcing its intention to cut 1,500 jobs, United Technologies

slashing its 2012 sales forecast, and 3M revising its full-year earnings expectations lower. As of Oct. 25, 43 companies

have provided earnings per share guidance for the fourth quarter, 33 of those are negative, eight are in line, and only two

are positive. This gives us a negative-to-positive ratio of 16.5, the highest since we began collecting these data in 2000. The

negative guidance seems to be concentrated within the consumer discretionary and information technology sectors, both

with nine companies providing downward guidance (see table 2).

Table 2

Negative Earnings Per Share Guidance For Fourth-Quarter 2012, By Sector

Consumer discretionary 9

Consumer staples 1

Energy 0

Financials 2

Health care 3

Industrials 5

Information tech 9

Materials 3

Telecommunications 0

Utilities 1

Total 33

Source: S&P Capital IQ.

The weak outlook has driven analysts to ratchet down fourth-quarter estimates, which hit a low of 8.1% on Thursday,

from previous double-digit expectations of 14.4% at the beginning of the calendar quarter on July 2 (see chart 1). In fact,

analysts have revised all forward-quarter expectations down, except for the fourth quarter 2013. However, double-digit

growth estimates for the second quarter of 2013 through the fourth quarter of 2013 are still holding strong.


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Chart 1

In addition to guidance, the number of companies missing revenue targets has also been a big concern this reporting

season. Through Thursday, only 41% beat revenue estimates, compared with the 10-year average of 61%. This is the

lowest revenue beat rate since we began collecting these data in 2002. Nearly 30% of S&P 500 companies that reported

results beat earnings-per-share estimates, but missed revenue estimates. GMI Research believes companies now have

squeezed costs as much as possible, so if S&P 500 corporations are to grow, they must increase sales. Next week marks

the third peak week for corporate earnings, with 110 companies scheduled to report.

Europe

In the U.S., better-than-expected third-quarter earnings results for S&P 500 companies helped lift the overall 2012 growth

rate to 4.3%, which is the opposite for the S&P Europe 350 Index. For the first time since we have tracked 2012 earnings

expectations, analysts expect the index to post a loss of 0.25%, compared with 2011. This is of particular concern because

the companies in the S&P Europe 350 Index are up against a low base from 2011: Last year's earnings "growth" was

negative 1.91%. Growth expectations for the index fell 0.27 percentage points in the past two weeks. Analysts expect five

of the 10 sectors--energy, materials, health care, information technology, and telecommunication services--to report

negative growth for 2012.


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Chart 2

In the past week, analysts made the most significant cuts to the consumer discretionary sector, with growth estimates 1.6

percentage points lower since the last edition of this report (see "Lookout Report: Jobs, Conspiracy Theories, And The

True State Of The U.S. Economy," published Oct. 12, 2012, on Ratings Direct). This is in direct contrast to what that

seen in the S&P 500 Index, where the consumer discretionary sector edged slightly upward in the past few days. Estimates

for the sector remain strong, however, and now stand at 6.17%, the second strongest sector in the S&P 350 Index after

the financials. This week, only three consumer discretionary firms reported for the first half of 2012, two beating analysts'

estimates and one missing. Whitbread PLC released first-half results on Tuesday, reporting earnings per share of €1.02,

missing analysts' estimates by €0.06, yet growing 20% year over year. Luxxottica Group SpA also released first-half

results this week, reporting earnings per share of €0.73, beating estimates by €0.12 and increasing 21% from the first half

of 2011. Automaker Daimler AG also beat first-half earnings estimates, reporting €3.35, €0.15 higher than analysts

expected, but just short of last year's result.


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Chart 3

Next week the earnings parade continues for the S&P 350 Index, with 40 companies expected to report. Currently, only

187 companies are scheduled to release results for the quarter, and based on that sample, earnings are seen growing by

2% from the third quarter of 2011. Unsurprisingly, the biggest losers for the quarter mirror expectations for the year, with

analysts expecting the information technology and materials sectors to be the biggest offenders, with estimates of negative

growth of 49.1% and 30.2%, respectively.

Estimated growth for 2013 still remains high at 11.34%, although this is down by 0.36 percentage points since Oct. 17.

Analysts expect all sectors to report growth next year, with the exception of the telecommunication services (negative

0.46%) and utilities (negative 1.54%) sectors. The information technology (45.45%) and financials (21.9%) sectors are

projected to lead growth next year.

Contact Information: Christine Short, Senior Manager—Global Markets Intelligence, [email protected]

International Update: A Sound Policy Climate And A Stable Political Regime Underpin TurkishShares

A languishing economic expansion and a menacing border skirmish would ordinarily render a national stock market

unworthy of an accentuated portfolio exposure, but--in the case of Turkey--unassailably sound official policies, fortified

by stable internal politics, entitle the Istanbul Stock Exchange (XU100) to a still-solid emerging equity market holding,

pending forthcoming developments in business activity. Rapid tapering of the nation's current account gap is also

reinforcing investor confidence in the fiscal and monetary programs of the reigning nine-year old Justice and Development

party (AKP) government, under well-respected Prime Minister Erdogan.

Economic trends on a number of fronts appear to make the Turkish stock market a highly undesirable avenue for

investment. Indeed, high unemployment, falling industrial output, and accelerating price pressures all spell a further


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gradual ebbing of the economy during the remainder of this year and early 2013. However, an anticipated rebalancing of

economic forces driving real GDP momentum should shift the source of strength from external to domestic demand,

which should restore the tempo of activity firmly to the upside next year. A projected 4.3% growth rate in 2013,

following a 5.5% point slowdown to 3% this year, is a significant improvement from forecasts of a lackluster 2012

performance.

Favorable external account trends and internal economic dynamics aside, the main backdrop for an expected revival in

macroeconomic conditions is the unconventional credit policy followed by the Turkish central bank. In lieu of undertaking

a head-on assault to restrain intensifying inflationary pressures through comprehensive monetary tightening, the Central

Bank of Turkey (CBT) opted to restrict hot money flows and buttress foreign demand via a relaxation of credit. But the

CBT faces a precarious dilemma: It needs to lower living costs, keep exports competitive, and nurture foreign investment

anew simultaneously, which will eventually challenge the efficacy of its unorthodox posture.

Trading at a 2012 forward price/earnings multiple of 11.5x (see chart 4), the XU100 may exceed its historical average of

9.8x. Still, it is vastly lower than the 26.4x all-time high. Even so, the XU100 appears far more expensive compared with

most of its Eastern European, Middle Eastern, and African (EEMEA) competitors: Warsaw (10.1x), Budapest (9.8x),

Athens (9.4x), Tel Aviv (8.3x), Bucharest (7.2x), Eastern Europe as a whole (6.0x), and Moscow (5.2x). The only EEMEA

rival against which Istanbul is valued relatively cheaply is South Africa, at 12.8x. Regardless of the unpropitious valuation

comparisons, the fact that the XU100 is the third-strongest performing shares market so far this year, no matter in which

major currency its returns are denominated, is incontrovertible evidence of investors' sanguine outlook for the Turkish

economy.

Chart 4


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With external influences expected to yield in potency while internal sources of demand increase in strength to drive the

domestic recovery next year, Turkish equities--especially infrastructure, financials, and consumer discretionary--should

remain a core holding of investment portfolios in light of the AKP regime's commitment to budgetary probity and the

central bank's responsibly flexible, though nonconformist, monetary policy.

Contact Information: John Krey, Director—Global Markets Intelligence, [email protected]

S&P Index Commentary: Fourth-Quarter Estimates Reflect A Disconnect

Although third-quarter actual earnings have painted a disappointing picture (especially because they were lowered

continuously before earnings season began), they have not been devastating: 62.9% of companies beat the S&P Capital IQ

consensus estimates, compared with the historical average of 62%. The estimated growth rate for S&P 500 earnings in the

third quarter is 1.14%, which compares favorably to the forecast for negative growth of 1.36% prior to the unofficial

launch of the reporting season on Oct. 9.

Much of the forward guidance offered by S&P 500 companies (and some are not saying anything) is negative; still,

consensus estimates have not declined, with fourth-quarter bottom-up operating earnings forecasting an 8.48%

year-over-year gain.

With the fiscal cliff approaching and companies warning about future profits, the rationale that consumers will spend

more freely eludes us, as does the expectation for double-digit margins in the fourth-quarter (based on sales estimates).

While large-cap issues have a two-year record of doing better than the general economy, and companies typically guide

analysts to lower their estimates in order to beat them, the current consensus forecast appears to us to be disconnected

from guidance.

With the fourth quarter underway, some retailers have already started their holiday push; the U.S. presidential election is

less than two weeks away; and the lame-duck Congress is scheduled to return Nov. 27. We believe that, if estimates are

going to change, analysts will change them soon. If not, we have not much longer to wait for reality.

Contact Information: Howard Silverblatt, Senior Index Analyst—S&P Dow Jones Indices, [email protected]

Leveraged Commentary And Data: The Sharpe Ratio Of S&P/LSTA Index Hits A 57-Month High

After plunging in the aftermath of the 2008 crash, the risk/return profile of leveraged loans--as measured by the Sharpe

ratio of the S&P/LSTA Leveraged Loan Index--has been on the comeback trail as a result of rising loan returns and ebbing

volatility. The data tell the tale (see chart 5).


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Chart 5

As a result, the Sharpe ratio of the index climbed to a 57-month high of 0.42 in September, from 0.35 at year-end and an

all-time low of negative 0.29 in December 2008 (see chart 6).

Chart 6


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This revitalization story is hardly unique to loans, of course. Each of the five asset classes that LCD tracks monthly has

seen a similar pattern, though loans crashed the hardest and have recovered the most (see chart 7).

Chart 7

As the following table shows, loans remain furthest from their pre-crisis heyday. Between January 1997 and June 2007, in

fact, the S&P/LSTA Index Sharpe ratio was the undisputed champ.

Table 3

Sharpe Ratio

All Loans ML High-Yield ML 10-year Treasuries S&P 500 ML High Grade

June 2007 0.95 0.44 0.26 0.41 0.60

Dec. 2008 (0.29) (0.01) 0.51 0.07 0.33

Sept. 2012 0.42 0.52 0.54 0.29 0.77

Sources: S&P Capital IQ LCD and Bank of America Merrill Lynch.

Looking ahead, participants think that loans' Sharpe ratios will continue to trend higher as long as today's relatively calm,

low-default environment persists. For one thing, loans' DNA as a bank product--collateral protection, floating-rate

coupons, and prepayment options--acts as a brake on volatility. For another, the 2008/2009 crisis drove most of the

leveraged, mark-to-market money out of the loan market, such as total-rate-of-return swap programs and market-value

CLOs. When many of those products were unwound in the fourth quarter of 2008--precipitating at least $5.1 billion of

BWICs, as tracked by LCD--it severely exacerbated the free fall in loan prices.

Finally, the four other asset classes tracked here have benefited greatly over the past four years from the Federal Reserve's

heroic efforts to bring down rates across the curve through three rounds of quantitative easing and Operation Twist. As a


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result, the 10-year Treasury constant maturity yield has crashed to 1.72% as of Sept. 30, from 5.1% in July 2007,

according to the Federal Reserve. Given current rate levels, loans are unlikely to lose much more ground versus

fixed-income asset classes and equities as a result of further rate declines.

Still, few expect the loan market to recapture the risk/return glory that preceded the credit crisis, when loans towered over

most other investment products, including high-yield and equities. Rather, participants expect loans to continue to run in

the context of other asset classes.

Contact Information: Steve Miller, Managing Director—Leveraged Commentary And Data,

[email protected]

R2P Corporate Bond Monitor

After a flurry of accommodative monetary policy measures at the last meeting in early September, market analysts expect

the Federal Open Markets Committee to maintain the status quo. The Fed vowed last month to keep interest rates below

0.25%, with $40 billion per month of new stimulus, until unemployment recovers. With the Fed taking unprecedented

steps to support growth, American companies remain better positioned relative to their European peers amid concern

about unemployment and manufacturing growth.

In Europe, leaders in Brussels agreed to have the legal framework for the eurozone (European Economic and Monetary

Union) banking regulator in place by the end of the year to be implemented through the course of 2013.

In this context, risk-reward profiles--as measured by average Risk-to-Price (R2P) scores--improved overall in Europe and

North America in the two weeks from Oct. 5 to Oct. 18 (see tables 4 and 5). Risk-reward balances improved in all but the

North American health care and telecommunication services sectors.

In North America, scores increased by 3% as a result of a 6% decrease in the average bond price volatility, and a 2%

widening in the average option-adjusted spread (OAS).

In Europe, scores increased by 20%, as a result of a 6% decrease in the average probability of default (PD), and a 26%

decrease in the average bond price volatility, offsetting a 3% tightening in the average OAS.

Table 4

North American Risk-Reward Profiles By Sector--Average R2P Score And Components Changes

Scores (%) OAS (bps) PD (%) Bond price vol. (%)

Consumer discretionary 6 (1) (5) (4)

Consumer staples 11 3 (6) (14)

Energy 2 2 (2) (9)

Financials 1 (3) 25 (6)

Health care (7) (5) 39 (6)

Industrials 10 2 (11) (9)

Information technology 0 4 16 (7)

Materials 3 17 (25) 1

Telecommunication services (7) 1 (25) 7

Utilities 6 (2) (5) (14)

Change as of Oct. 18, 2012, from Oct. 5, 2012.


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Table 5

European Risk-Reward Profiles By Sector-- Average R2P Score And Components Changes

Scores (%) OAS (bps) PD (%) Bond price vol. (%)

Consumer discretionary 19 (8) (10) (19)

Consumer staples 17 (3) (11) (23)

Energy 22 (7) (3) (13)

Financials 21 (2) 4 (36)

Health care 7 (6) (5) (22)

Industrials 18 1 23 (28)

Information technology 30 12 (19) (38)

Materials 9 (5) (8) (11)

Telecommunication services 25 (10) (8) (32)

Utilities 29 (3) (23) (42)

Change as of Oct. 18, 2012, from Oct. 5, 2012.

Contact Information: Fabrice Jaudi, Senior Director—Global Markets Intelligence, [email protected]

Municipal Bond Commentary: The Riskiest Municipal Bonds Are Pulling Up The High-YieldMarket

Municipal bond funds have seen steady cash inflows, maintaining the demand/supply imbalance and continuing to hold

yields down. High-yield municipal bonds, as tracked by the S&P Municipal Bond High Yield index, keep inching upward,

outpacing the general market and helping boost the index's total return of 15.36% year to date. The weighted average

yield of these bonds has fallen 122 basis points (bps) since year end; the yield spread between investment-grade and

high-yield municipal bonds narrowed slightly to 317 bps, near historical lows (weighted average yields of bonds in the

S&P National AMT-Free Municipal Bond index (National AMT-Free) and S&P Municipal Bond High Yield index). An

example is the tobacco settlement bond sector, which returned more than 19.45% this year (see table 6). These bonds

seem attractive to funds seeking yield, but are among the riskier sectors in the municipal bond market, with long durations

and uncertain prospects based on the changing behavior of consumers. If irrational investor behavior sets in and cash

inflows to funds turns to an ebbing tide, the high-yield sectors of the municipal bond market will be hardest hit.

Investment-grade municipal bonds tracked by the National AMT-Free index also saw yields pushed lower, lifting the

weighted average yield to worst to 1.98% (a 3.05% taxable equivalent yield). Investment-grade municipal bonds saw a

6.44% year-to-date return.

Revenue bonds outpaced general obligation bonds (GO) with the S&P Municipal Bond Revenue index returning 8.19%,

while GO bonds tracked in the S&P Municipal Bond General Obligation index showed a return of 5.69%. State GO

bonds are still underperforming relative to locally issued GO bonds, with State GOs returning 4.96% versus local GOs

returning 6.69% year to date. Key states outperforming the municipal bond market so far in 2012 are California (8.09%),

Colorado (8.39%), Illinois (8.21%), Ohio (8.78%), and New Jersey (7.84%).

Table 6

Year-To-Date Returns

(%)

S&P Municipal Bond Tobacco Index (Tobacco Settlement Bonds) 19.45

S&P Municipal Bond Land Backed Index 10.91

S&P Municipal Bond Health Care Index 9.98


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Table 6

Year-To-Date Returns (cont.)

S&P Municipal Bond Multifamily Index 7.25

S&P Municipal Bond State General Obligation Index 4.96

S&P Municipal Bond Local General Obligation Index 6.69

Source: S&P Dow Jones Indices.

James Rieger, Vice President—S&P Dow Jones Indices, [email protected]

Fixed-Income Commentary: International Bonds Offer Portfolio Diversity

U.S. investor sentiment was bearish at 44.55% last week, according to the American Association of Individual Investors

(AAII) Sentiment Survey. This weekly survey of its members asks if they are bullish, bearish or neutral on the stock market

over the next six months. Although not as high as the 56.72% reached in February 2009, this is still a strong sentiment

when coupled with 26.8% neutrality. Financial regulatory expectations, earnings outlook, the pending U.S. presidential

election, and low interest rate environment present some tough challenges for investors.

Fixed income has seen a consistent inflow of funds as investors reach for additional yield and the safety of predictable cash

flows. Investor interest in bond exchange-traded funds (ETF) has remained strong as $2.6 billion of inflow for 21

consecutive months has been measured by Lipper and Thomson Reuters' analytics. Along with allocating money to U.S.

corporates, investors should consider their global exposure. The S&P International Corporate Bond Index (SPBDICBT)

has returned 12.16% year-to-date: This is an investible market-weighted index of non-U.S. dollar corporate bonds issued

by non-U.S. investment-grade issuers (see chart 8). The index seeks to measure the performance of corporate bonds issued

in the non-U.S. dollar G10 currencies. When compared with the Dow Jones U.S. Corporate Index (10.69%, year to date)

and the S&P 500 (12.37%, year to date), international bonds are an additional investment option. The tracking ETF

product to the S&P International Corporate Bond Index is the PowerShares International Corporate Bond Portfolio

(PICB).


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Chart 8

Contact Information: Kevin Horan, Director—S&P Dow Jones Indices, [email protected]

Market Derived Signal Commentary: Weak Earnings And Bleak Outlook Send IT PremiumsHigher

From Sept. 14 through Oct. 19, 2012, the S&P 500 Index has given back 2.22%, and information technology (IT) has

been largely to blame, declining 7.8% over the period. According to GMI Research's colleagues at S&P Indices, the S&P

500 would have lost 0.96% if technology was excluded. Technology issues accounted for 12 of the 25 stocks with the

most significant declines, and Advanced Micro Devices Inc. led the group, with a drop of 44.1% (see chart 9).


15 October 26, 2012

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Chart 9

At present, the Capital IQ consensus expects the sector to report earnings growth of 0.93% for the third quarter, better

than five other sectors, but certainly nothing to cheer about. So far in the third-quarter reporting season, only 57.14% of

IT companies have eclipsed analysts' forecasts for earnings per share, lower than the current S&P 500 average of 62.91%

and the historical average of 62%.

It was no surprise then to find that the average spread for IT five-year credit default swaps (CDS) widened nearly 12%

over the past 30 days and by 3.3% over the week ended Oct. 22, as earnings got underway. The average spread for IT

companies was 392 bps, according to CMA, an S&P Capital IQ business. Advanced Micro Devices' CDS spread widened

39% over the past week alone to 1,073 bps.

Companies have cited the challenges associated with operating a business during such severe global economic uncertainty,

and that environment is not likely to change in the fourth quarter. Although this is by no means news, we believe the

persistence of the trend adds to investor agitation about sector-specific problems.

In reporting a third-quarter loss, Advanced Micro Devices said it would restructure the company, including a 15%

workforce reduction, to cut operating costs and put the company in a better competitive position. "The PC industry is

going through a period of very significant change that is impacting both the ecosystem and AMD," the company said. "It

is clear that the trends we knew would re-shape the industry are happening at a much faster pace than we anticipated."

Intel Corp. stated: "Our third-quarter results reflected a continuing tough economic environment." Revenues fell to $13.5

billion from $14.2 billion in the year-ago period, and although per-share earnings of $0.60 beat the S&P Capital IQ

consensus estimate of $0.53, the figure was lower by 13% year over year. Competitor Texas Instruments Inc. said the

"…semiconductor market remained weak and likely will get weaker in the fourth quarter." It reported a 2% decline in

revenue year over year, although normalized earnings of $0.52 per share beat the consensus estimate by 13%. Still, EPS


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were lower than last year's quarter of $0.61.

Microsoft Corp.'s earnings and revenues missed the consensus forecast of $0.56 by $0.03 and fell short of the revenue

estimate of $16.43 billion by 2.5%. A mid-single-digit decline in revenues from Europe hurt results, and the company said

"the PC market was challenged this quarter." Microsoft is expecting Windows 8 to drum up interest in its new Surface

tablet, which launched on Oct. 25, and steal some market share from Apple Inc.'s iPad.

Despite the negative trend in the IT CDS, the risk premiums for many companies remain low, with Intel at 53 basis points

(bps), Microsoft at 31 bps, and Texas Instruments at 40 bps (see chart 10). Although Intel's spread is wider by 15% year

to date, Microsoft's CDS tightened 32% and Texas Instruments by 7.7%. We would begin to be concerned about credit

market sentiment if the premium for any of these names topped 100 bps.

Chart 10

On Oct. 26, the S&P Capital IQ consensus forecast fourth-quarter earnings growth of 3.66% for IT, down from 7% on

Oct. 19. Against this backdrop and with a number of companies yet to report third-quarter results (only 42 of 70 thus

far), we believe credit and equity investors will remain on high alert, and we will monitor the CDS spreads to see if there

are signs of worsening sentiment.

Contact Information: Lisa Sanders, Director—Global Markets Intelligence, [email protected]

Capital Market Commentary: U.S. IPOs Priced In 2012

IPOs

The recent announcement by Facebook Inc. that its third-quarter financial results exceeded analysts' consensus


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expectation perhaps should come as little surprise. From the perspective of recently completed initial public offerings

(IPOs), more often than not, earnings results have managed to come in above the expectations of Wall Street. Of the 36

U.S.-based IPOs that reported first-quarter 2012 earnings, 56% beat analysts' forecasts (see table 7). The following

quarter, which saw 26 more companies reporting results than in the prior quarter, was marked by 71% of 2012 IPOs

topping estimates. Now, in the early stages of third-quarter earnings season for IPOs, each of three reporting

companies--including E2open Inc. and Del Frisco's Restaurant Group LLC--reported results surpassing forecasts. Next

week, S&P Capital IQ data show 17 IPOs scheduled to release financial results, including Brightcove Inc. on Oct. 30 and

Yelp Inc. on Nov. 1.

Table 7

U.S. IPOs Priced To Date In 2012--Earnings Surprises

--2012--

Aggregate Results First quarter Second quarter Third quarter*

Total reported 36 62 3

Exceeded 26 41 3

Met 0 3 0

Missed 10 18 0

*Through Oct. 23. Source: S&P Capital IQ.

Merger & Acquisitions

While the pace of overall U.S. M&A volume in 2012 continues to lag the prior year's activity, there is at least one

promising trend at hand: A review of monthly U.S. announced merger and acquisitions (M&A) valued at $1 billion shows

that, with one week left in October, this month is poised to be the most active period this year for such deals. There have

been 15 U.S. M&A deals of $1 billion to date this month, up from 10 in September, and within striking distance of the

year's 19 billion-dollar plus deals (see chart 11). Big U.S. M&A deals taking place this month include SOFTBANK

CORP., entering into a definitive agreement on Oct. 15, 2012, to acquire a 55% stake in Sprint Nextel Corp. for $12.1

billion in cash; ASML Holding NV agreeing on Oct. 16, 2012, to acquire Cymer Inc. for $2.67 billion in cash and stock;

and Permira Investments Limited and Spectrum Equity Investors agreeing on Oct. 21, 2012, to acquire Ancestry.com Inc.

for $1.4 billion.


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Chart 11

Debt

A review of recent debt-related security identifier requests reveals mixed results. Based on information provided by CUSIP

Global Services, for the weekly period ending Oct. 19, domestic corporate debt, municipal securities, and international

debt were among the asset classes seeing a rise in CUSIP requests (see table 8). On the other hand, CDs with maturities

over one year were the only debt-related assets to see a drop in identifier requests during the past reporting week.

Municipal-debt CUSIP orders dominate to-debt CUSIP orders: They were 51% of the past week's identifier order among

major debt categories, matching the market share for debt-related CUSIP activity during the week ending Oct. 12.

Table 8

Debt Security CUSIP Activity

CUSIPs processed and billed

Week ended

10/19

Week ended

10/12

2012, year to

date

2011, year to

date year-over-year change (%)

Domestic corporate debt 106 81 8,481 8,591 (1.3)

CTF DEP (maturities less than oneyear)

48 33 3,111 3,056 1.8

CTF DEP (maturities over oneyear)

57 65 6,070 6,582 (7.8)

Municipals 379 314 13,622 10,263 32.7

Long-term note (more than oneyear)

11 5 482 340 41.8

Short-term note (less than oneyear)

37 30 1,283 1,397 (8.2)

International debt 61 47 1,399 1,240 12.8

PPN domestic debt 48 38 1,812 1,542 17.5

Source: CUSIP Global Services.


19 October 26, 2012

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Contact Information: Rich Peterson, Director—Global Markets Intelligence, [email protected]

S&P Index Commodity Commentary: Industrial Metals Lead October Declines

Commodities have come under pressure in October--along with most other risk assets--because of global economic

concerns, measured by the 4.22% month-to-date decline in the S&P GSCI (Oct. 24). The economy-sensitive industrial

metals sector led decliners, measured by the 7.49% decline in the S&P GSCI Industrial Metals index, reversing gains in the

broad S&P GSCI to show a loss of 0.89% for 2012. Only the livestock sector gained in October, measured by the 3.06%

month-to-date increase in the S&P GSCI Livestock index. Diminishing supplies because of the drought, with increasing

global demand and declining feed grain prices have supported livestock prices recently. Year-to-date, agriculture remains

the strongest-performing major sector, as measured by the 16.65% 2012 gain in the S&P GSCI Agriculture index,

although lessened by the 1.51% decline in October. Better-than-expected Northern Hemisphere harvest results pressured

grains recently, but drought-diminished yields in some of the world's major growing regions have helped the S&P GSCI

Grain index become the best-performing sub-index, with a 2012 gain of 29.56%.

Energy compared with non-energy

Because of its greater world-production-based weight in the broad S&P GSCI, the 4.99% month-to-date decline in the

S&P GSCI Energy index has been the largest drag on broad index returns, in October and in 2012. Year-to-date, the S&P

GSCI Energy index ended Oct. 24 with a decline of 4.47%, compared with a gain of 7.49% for the S&P GSCI

Non-Energy index. The largest single commodity drag on energy returns thus far in 2012 is U.S. based WTI crude oil, as

measured by the 16.42% year-to-date decline in the S&P GSCI Crude Oil index. Due to refinery-related supply issues and

rolling into a backward shaped future curve (when further out futures trade at lower prices), unleaded gasoline has been

the best-performing commodity in the energy sector in 2012, as measured by the 20.67% increase in the S&P GSCI

Gasoline index despite a 7.25% decline in October. Year-to-date, the spot S&P GSCI Unleaded Gasoline index has

actually declined 2.49%. Declining energy costs in North America are becoming quite compelling and global business is

responding accordingly, as evidenced by the front page article in the Oct. 24, 2012 edition of the Wall Street Journal,

"Cheap Natural Gas Gives New Hope to the Rust Belt." Many analysts have noted that since 2008, the energy sector has

been relatively highly correlated to the S&P 500 Index. Many hope that the fundamental differences in asset classes will

prevail and recent weakness in energy prices will be beneficial to business and consumers, subsequently supporting equity

prices.


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Chart 12

Contact Information: Mike McGlone, Senior Director—S&P Dow Jones Indices, [email protected]

About S&P Capital IQ and S&P Indices Research & Analytics

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