lookout report - s&p global...the aggregate corporate earnings of the constituents of the...

Third-Quarter S&P 500 Earnings Are A Potential Springboard ToSustained Double-Digit Corporate Earnings Growth

The aggregate corporate earnings of the constituents of the S&P 500 index had previously been

expanding at a low- to mid-single-digit growth rate between first-quarter 2012 and first-quarter

2014. This moderate growth continued until the recently completed second-quarter 2014

earnings season when initial expectations of sub-7% growth turned out to be too conservative

relative to the final reported earnings growth of 10.7%. Looking ahead to the third-quarter

earnings season (Alcoa unofficially kicks off the third-quarter earnings season on Oct. 8),

investors are once again anticipating sub-7% (6.7%) third-quarter earnings growth, according

to S&P Capital IQ consensus data. However, Global Markets Intelligence (GMI) Research

anticipates a repeat of what occurred in the second quarter because we suspect that the

third-quarter's results could ultimately end up close to, or even above, the 10% mark. Should

this occur, these two quarters would be the first consecutive quarters of double-digit earnings

growth since the early years of the economic recovery in 2010 and 2011, when relatively easy

year-ago comparative earnings per share numbers helped drive historically respectable

double-digit S&P 500 earnings growth. Following these two quarters, Wall Street analysts

forecast at least an additional five quarters of double-digit S&P 500 profit growth, extending at

least through calendar year 2015, according to data aggregated by S&P Capital IQ.

If accelerating corporate earnings growth is the headline story, then job creation, the U.S.

consumer, and ultimately the Federal Reserve and U.S. monetary policy must be the subtext.

From a macroeconomic overview level, we believe that U.S. income growth drives consumption,

and that consumption trends drive both GDP and corporate profit growth. The Federal Reserve

typically acts as the referee in this process, seeking to maximize domestic employment while

simultaneously safeguarding the integrity of the U.S. dollar by insuring that inflation remains

constrained. Considering that we could very well be on the threshold of sustained double-digit

earnings growth, the economy's performance will now be benchmarked against investor

expectations for resurgent corporate profit growth at a time when the Federal Reserve is also

expected to begin normalizing monetary policy at mid-year 2015.

Taking a more detailed look at our subtext themes, the U.S. economy appears to be doing just

fine. The three-month average rate of non-farm payroll creation stands at 224,000 as of

September, which is just above the mid-point of the 100,000-300,000 range that prevailed

Lookout Reportfrom Global Markets Intelligence

October 3, 2014

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 Dow

Jones 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.

29092680 | 270752268

between 2004 and 2007 during the prior economic expansion cycle in addition to the existing recovery cycle since 2010

(see chart 1). Retail sales have also remained strong since the end of the recession in June 2009, setting new all-time record

highs in March 2011. U.S. retail sales have continued to set new record highs since, reaching $444.4 billion in August

2014 (see chart 2).

Chart 1

Third-Quarter S&P 500 Earnings Are A Potential Springboard To Sustained Double-Digit CorporateEarnings Growth Lookout Report from Global Markets Intelligence

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Chart 2

The Fed's efforts to normalize monetary policy in the coming months and the extent to which they will complicate

investor expectations for economic growth and a sustained acceleration of corporate earnings remain unknown. The

concerns are wide ranging, including the resolution of the highly publicized debate within the Federal Open Market

Committee (FOMC) between the hawks and the doves, the timing and extent of the normalization of U.S. interest rates,

and the impact of marginally higher rates on household consumption, housing, corporate funding expense, and corporate

profitability. All of these factors will influence the longevity of the economic recovery cycle. In our view, the Federal

Reserve could actually turn out to be less of a concern than many market participants, GMI Research included, may have

initially believed. As the Fed winds down its quantitative policy influence in the financial markets, the relatively untethered

market's response could do much of the normalization heavy-lifting for policymakers. The future direction of bond prices,

including the slope of the yield curve, combined with developments in the foreign exchange market, including a further

strengthening of the U.S. dollar, are likely to play an increasing role in the Fed's policy deliberations.

Returning to the outlook for third-quarter S&P 500 earnings growth and stock market performance, the resumption of

respectable and often better-than-expected quarterly earnings in recent years has proven to be the backbone of this bull

market since its inception in March 2009. Sustained earnings growth has consistently propelled the market higher, often in

direct opposition to highly publicized concerns such as the "fiscal cliff," federal budget sequestration, and now Federal

Reserve monetary policy. Expectations for a resumption of double-digit earnings growth bodes well for the outlook for

stocks, assuming Fed policy and the entire interest-rate normalization process turns out to be little more than a technical

adjustment for investors to contend with.


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Inside This Issue:

Macroeconomic Overview

S&P 500 profits had previously been expanding at low- to mid-single-digit growth rates between the first quarter of 2012

and the first quarter of 2014. This sustained growth held true until the recently completed second-quarter 2014 earnings

reporting period when initial sub-7% expectations turned out to be too conservative relative to final reported earnings

growth of 10.7%. If third-quarter earnings surprise on the upside, in the vicinity of the performance reported in the

second quarter, these will be the first back-to-back quarters of double digit earnings growth produced by S&P 500

corporations in three years.

Economic And Market Outlook: North American And European Earnings

The consensus expects just under 7% quarterly earnings growth versus the comparable year-ago quarter. Strength is likely

to come from telecommunications (14.6%), materials (12%) and health care (11.3%). Consumer staples (2.9%) and the

financial sectors (3.9%) lag behind. All 10 industry classification sectors are expected to produce positive earnings growth

in the third quarter of 2014.

International Update: Policy Divergence Recommends Barbelling Short-Duration U.S./U.K. Debt And Long-Duration Eurozone

Debt

If inflation is any guide to the direction and magnitude of changes in a country's interest rates, central banks in the process

of normalizing credit policy, namely, the Federal Reserve (Fed) and the Bank of England (BoE), are receiving poor

guidance from current trends in their nations' respective costs of living. The year-over-year percent change in the U.S.

consumer price index (CPI) is presently 1.7%, only 0.6 percentage points higher than its cyclical 1980s low of 1.1% when

the monetary authorities on both sides of the Atlantic first confronted and then triumphed in subduing the menace of

chronic double-digit price pressures.

S&P Dow Jones Index Commentary: The Buyback Movement Slows

The total value of S&P 500 stock buybacks decreased by 1.6% to $116.2 billion during second-quarter 2014, down from

$118.1 billion during second-quarter 2013, according to preliminary data collected by S&P Dow Jones Indices. The

$116.2 billion spent in the second quarter also represents a 27.1% decline from first-quarter 2014's $159.3 billion of

stock buybacks, which was the second largest quarter for stock buybacks on record.

Leveraged Commentary And Data: Leveraged Loans Lose 0.6% In September; Year-To-Date Return Is 2.11%

After gaining 0.15% in August, the S&P/LSTA Leveraged Loan Index fell 0.60% in September, its worst monthly

performance since June 2013. Loan prices sagged during the month amid heavy market conditions, particularly over the

final week of the month, when the Index slid 0.30%. Moreover, with retail funds selling liquid paper to meet another

month of redemptions, the large loans that constitute the S&P/LSTA Loan 100 lost ground to the broader market, with a

0.96% decline in September. In August, by contrast, the Loan 100 outperformed, with a 0.24% gain.

R2P Corporate Bond Monitor

The U.S. Department of Commerce's latest revision confirmed second-quarter growth of 4.6%, up from the previously

estimated 4.2%. The revision reflected higher exports and business activity. Along with fairly strong employment data

from the past few months, the revision points to a strong third quarter. In Europe, quantitative easing expectations could


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increase following banks' low take-up of the European Central Bank's (ECB's) recent long-term, low-cost loan offering

through its Targeted Long Term Refinancing Operation (TLTRO). Furthermore, September's economic sentiment index

deteriorated to 99 from 100.6 in August, according to the European Commission, as retailer and consumer confidence fell.

Capital Market Commentary: IPOs, M&A, And Debt

The most recent quarter was one of the most active periods for IPO underwriting in the past few years. The board of eBay

Inc. has announced that the company intends to spin off its online payment operator PayPal Inc. as a separate,

publicly-traded company. We saw mixed results in September as three of the six regularly surveyed debt asset classes saw a

decline in their number of CUSIP orders.

Economic And Market Outlook: North American And European Earnings

North America

With just over a week until the start of the third-quarter S&P 500 earnings season, the S&P Capital IQ consensus forecast

for third-quarter earnings growth stands just below 7% compared with same quarter a year ago. The sectors where we

expect to see strong growth are telecommunications (14.6%), materials (12%), and health care (11.2%), while the

consumer staples (2.9%) and financials (3.95%) sectors are likely to be the laggards this season. All 10 industry sectors

are expected to produce positive earnings growth for third-quarter 2014 (see table 1).

Table 1

North America Third-Quarter Industry Expectations

EPS ($) Growth (%)

Consumer discretionary 6.76 6.07

Consumer staples 6.21 2.92

Energy 11.43 6.87

Financials 5.18 3.95

Health care 10.27 11.17

Industrials 6.98 8.54

Information technology 9.25 5.24

Materials 3.80 11.91

Telecommunication services 2.88 14.60

Utilities 4.22 4.70

S&P 500 29.31 6.67

EPS--Earnings-per-share. Source: S&P Capital IQ.

Third-quarter S&P 500 earnings-per-share (EPS) expectations have recently settled in at $29.31, representing 6.7%

growth, having been as high as $30.77/9.6% as recently as mid-to-late July 2014 (see chart 3). S&P 500 third-quarter

revenues are expected to increase 3.9% compared with the year-ago quarter, suggesting a slight pullback from the 4.5%

revenue growth that we recorded in the prior second-quarter reporting period.


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Chart 3

The consumer discretionary sector is expected to see earnings growth of 6.1%, led by the multiline retail (89%), specialty

retail (10.4%), and distributor (10.1%) industries that offset the weakness in autos (-26.9%), leisure (-4.5%), and

diversified services (-2.6%). Third-quarter financial sector earnings are expected to grow by 4%, led by the real estate

investment trust (REIT) (28.4%) and real estate management and development (28.4%) industries, which offset the

weakness in diversified financial services (-23.4%) and thrifts and mortgage finance (-12.4%). Technology earnings are

expected to grow by 5.2%, reflecting strength in the semiconductors (21.5%), computers and peripherals (8.1%), IT

services (7.9%), and office electronics (7.5%) industries that is offsetting the weakness in software (-9.1%) and internet

software and services (-1.1%).

Europe

European corporate earnings, as benchmarked by aggregate S&P Euro 350 consensus expectations for calendar year 2014

and 2015, continue to hold up better than the recent eurozone economic data might otherwise suggest. Analysts forecast

11% S&P 350 earnings growth in 2014 to be followed by 12.7% profit growth in 2015. This compares with expected

growth rates of 9.8% and 12.9%, respectively, recorded one month ago.

Consensus forecasts suggest that the strongest 2014 growth will come from the information technology (56.7%) and

financials (24.3%) sectors, while year-on-year declines are expected for the utilities (-6.2%) and telecommunications

services (-3.7%) sectors (see table 2).


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Table 2

European Third Quarter Industry Expectations

--Calendar year 2014-- --Calendar year 2015--

EPS (€) Growth (%) EPS (€) Growth (%)

Consumer discretionary 111.21 16.40 127.34 14.50

Consumer staples 148.99 0.50 160.17 7.50

Energy Sector Index 128.99 14.70 138.94 7.70

Financials 64.08 24.30 75.32 17.50

Health care 113.13 8.10 122.99 8.70

Industrials 100.11 12.60 116.45 16.30

Information technology 51.01 56.70 63.93 25.30

Materials 153.67 15.90 178.94 16.40

Telecommunication services 74.27 (3.70) 77.36 4.20

Utilities 92.27 (6.20) 97.22 5.40

S&P 350 94.25 11.00 106.24 12.70

EPS--Earnings per share. Source: S&P Capital IQ.

International Update: Policy Divergence Recommends Barbelling Short-Duration U.S./U.K. DebtAnd Long-Duration Eurozone Debt

If inflation is any guide to the direction and magnitude of changes in a country's interest rates, central banks in the process

of normalizing credit policy, namely, the Federal Reserve (Fed) and the Bank of England (BoE), are receiving poor

guidance from current trends in their nations' respective costs of living. The year-over-year percent change in the U.S.

consumer price index (CPI) is presently 1.7%, only 0.6 percentage points higher than its cyclical 1980s low of 1.1% when

the monetary authorities on both sides of the Atlantic first confronted and then triumphed in subduing the menace of

chronic double-digit price pressures.

Inflation in the U.K. is also running at a 2.4% annual rate, matching its 1980s low of the same level but doubling that of

the 1990s. Parenthetically, inflation in the UK reached a thirty-year, normal cyclical low of 0.7 percent in December 2001

before capitulating to deflation for nine months in 2009 during the Great Recession. Similarly, U.S. living costs

surrendered briefly to an eight-month period of deflation in the same year as a result of the economy's severe contraction.


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Chart 4

The descending pattern of domestic price increases of late in both countries as well as in the eurozone raises a few critical

questions: Why are the Fed and BoE committed to normalizing their corresponding interest rate policies if the threat of

inflation is nowhere on the horizon? Further, why has the European Central Bank (ECB) been so slow to respond to the

threat of deflation when the trend since November 2011 has been exhibiting an unambiguous steady deceleration in the

speed of price rises to a fractional rate just shy of zero? Lastly, what are the ramifications for bond yield patterns in

addition to fixed income investments in the U.S., U.K., and the euro bloc of the divergences in timing and direction of the

three central banks' credit policy changes?

Mixed signals as to when the Fed and BoE should commence monetary policy normalization and by how much they need

to increase their lending rates will fuel debt market confusion and suspicion about the monetary authorities' intentions.

Both central banks are committed to a reversal of quantitative credit relaxation, but persistent concerns about slack labor

market conditions and weak nominal wage gains are discouraging Fed Chairwoman Janet Yellen and BoE Governor Mark

Carney from swiftly acting to lift policy rates. Although unemployment has considerably declined in both the U.K. and the

U.S., the benefits in terms of money wage gains have eluded both labor forces.

Current U.S. wage inflation is stuck in a narrow 1.4%-1.9% range with no apparent upside momentum, and nominal

U.K. labor costs have been subsiding since 2009 -2010 to a fractional year-on-year advance of 0.4%. Mirroring wage

trend fragility in the two labor markets, 10-year U.S. and U.K. inflation swap rates have decreased steadily, according to

Bloomberg, plummeting 36 and 39 basis points, respectively, after reaching highs of 2.66% for the former (July 25, 2014)


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and 3.54 percent for the latter (March 13, 2013).

Corroborating the tendency in the cost of living swaps markets, the recent descent in breakeven inflation rates of 10-year

U.S. Treasury inflation-protected securities (TIPs) to 1.9% indicates not just subsiding U.S. price pressure expectations but

also growing investor disbelief in the efficacy of the Fed's navigating demand and wages higher. Likewise, the U.K.'s cost

of living anticipations, measured by breakeven rates of inflation-linked U.K. sovereign issuance, have tumbled 83 basis

points to 2.72% from their 3.36% March 2013 high, demonstrating investor doubts about the effectiveness of the BoE's

quantitative easing.

With euro bloc inflationary pressures having decelerated close to the key zero mark separating inflation from deflation,

ECB President Mario Draghi and his supporters on the governing board appear to have squandered precious time in

postponing to last month a resolute decision on implementing quantitative monetary loosening to forestall the euro-land

economy from sliding into the self-perpetuating psychological abyss of falling living costs encouraging households to delay

consumption plans in anticipation of further price decreases. Imported sources of inflation have spurred euro-land price

pressures to retreat into negative territory in the past nineteen consecutive months.

What is most surprising about last month's ECB decision to ease quantitatively is not the board's sudden concern with the

270-point abatement in Euro-18 headline inflation since November 2011, but its categorical disregard of what the

inflation-swap and -linked markets had already been acknowledging for over three years. Ten-year euro currency

cost-of-living swap rates have plummeted 93 bps from a high of 2.41% nearly three and half years ago. Breakeven rates of

inflation-linked German debt issuance have followed the exact pattern as that of eurozone price pressure swaps, falling by

a larger magnitude of 120 bps from their April 11, 2011 high.

The monetary authorities on both sides of the Atlantic have underestimated the persistent power of underlying

disinflationary tendencies in their respective economies. The depressing economic impact of secular (noncyclical or

structural) stagnation on developed Western economies and labor markets remains unresolved. In acting determinedly

since the Great Recession, the Fed and the BoE seem to have undertaken the appropriate countercyclical action to repel

deflation. Nevertheless, structural stagnation denies them both the opportunity to declare victory because the easing has

not fed through to household incomes. Meanwhile, the ECB's delay in initiating aggressive easing to this past month

makes it nearly impossible for it to stave off deflation.

So, how should investors position their fixed-income holdings to protect against upside interest rate risk in the U.S. and

U.K. and benefit from further potential downside to sovereign yield trends in the euro bloc? In the case of the U.S.

Treasury and U.K. gilt exposures, preparation for the inevitable--an initial lending rate hike--requires an adjustment that

achieves first and foremost a shortening of the portfolio's duration of diversified government holdings as well as low- and

high-quality corporate issuance. As for eurozone bond exposures, a prolonged period of forceful monetary

accommodation would provide investors a bar-belling opportunity of lengthening duration of investment-grade

government bond holdings and shortening the same of the U.S. and U.K.

Contact Information: John Krey, International Investment Analyst—Global Markets Intelligence, [email protected]

S&P Dow Jones Index Commentary: The Buyback Movement Slows

The total value of S&P 500 stock buybacks decreased by 1.6% to $116.2 billion during second-quarter 2014, down from

$118.1 billion during second-quarter 2013, according to preliminary data collected by S&P Dow Jones Indices.

The $116.2 billion spent in the second quarter also represents a 27.1% decline from first-quarter 2014's $159.3 billion of

stock buybacks, which was the second largest quarter for stock buybacks on record.


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According to S&P Dow Jones Indices, S&P 500 issues increased their buyback expenditures by 26.6% to $533.0 billion

for the 12 months ended June 2014, up from $420.9 billion during the previous 12 months. The 12-month high was

reached in fiscal year 2007 when companies spent $589.1 billion on share buybacks. The 12-month recessionary low point

was $137.6 billion recorded in fiscal year 2009.

Table 3

S&P 500 Buybacks

Period

Market

value (bil.

$)

Operating

earning (bil.

$)

As

reported

earnings

(bil. $)

Dividends

(bil. $)

Buybacks

(bil. $)

Dividend

yield (%)

Buyback

yield (%)

Dividend

and

buyback

yield (%)

Dividends

and

buybacks

(bil. $)

6/30/2014 17,404.00 261.47* 241.76* 86.65 116.17* 1.91 3.06* 4.98* 202.82*

3/31/2014 16,699.76 243.67 221.82 81.96 159.28 1.93 3.20 5.14 241.24

12/31/2013 16,494.78 252.10 236.31 84.98 129.41 1.89 2.88 4.77 214.40

9/30/2013 14,960.48 239.50 219.13 79.26 128.16 2.05 2.98 5.03 207.42

6/30/2013 14,309.96 234.84 221.56 76.67 118.05 2.07 2.94 5.02 194.72

3/31/2013 13,978.82 229.57 215.76 70.86 99.97 2.06 2.97 5.02 170.82

12/31/2012 12,742.44 206.84 184.50 79.83 99.15 2.20 3.13 5.33 178.98

9/30/2012 12,881.02 214.58 189.64 69.48 103.72 2.07 3.01 5.08 173.20

6/30/2012 12,303.11 229.69 195.27 67.31 111.75 2.08 3.27 5.35 179.05

3/31/2012 12,730.25 219.09 208.15 64.07 84.29 1.95 3.14 5.09 148.37

12/31/2011 11,385.01 214.83 186.85 65.89 87.59 2.11 3.56 5.67 153.47

9/30/2011 10,303.14 230.30 206.08 59.20 118.41 2.22 3.92 6.14 177.61

6/30/2011 12,021.16 226.29 202.44 59.03 109.24 1.84 3.04 4.88 168.27

3/31/2011 12,067.74 205.34 195.15 56.08 89.84 1.76 2.76 4.52 145.91

12/31/2010 11,429.83 199.40 187.67 54.85 86.36 1.80 2.61 4.42 141.21

9/30/2010 10,336.29 195.28 176.80 51.26 79.56 1.94 2.52 4.45 130.81

6/30/2010 9,322.58 189.04 178.00 50.44 77.64 2.10 2.31 4.41 128.08

3/31/2010 10,560.00 175.00 157.85 49.28 55.26 1.83 1.54 3.36 104.54

12/31/2009 9,927.54 152.77 135.14 49.04 47.82 1.97 1.39 3.36 96.86

9/30/2009 9,336.51 139.37 130.37 47.21 34.85 2.24 1.48 3.71 82.06

6/30/2009 8,044.82 120.85 118.22 47.63 24.20 2.77 2.40 5.17 71.83

3/31/2009 6,927.59 87.78 65.29 51.73 30.78 3.43 3.70 7.13 82.51

12/31/2008 7,851.81 (0.78) (202.11) 62.19 48.12 3.15 4.33 7.48 110.31

9/30/2008 10,181.46 142.90 86.16 61.44 89.71 2.48 4.26 6.73 151.15

6/30/2008 11,162.57 148.43 112.15 61.94 87.91 2.26 4.62 6.88 149.86

*Preliminary values. Source: S&P Dow Jones Indices.

Buybacks are only half of the stock supply story, as company stock issuance (for employee options, mergers and

acquisitions, or financing) rounds out the second half. For second-quarter 2014, companies reduced their overall buyback

spending even as the average daily stock price rose 3.6%, resulting in fewer purchased shares. However, on aggregate,

companies also issued fewer shares, resulting in a lower share count and higher earnings per share (EPS).

By reducing their share count, companies are helping to lift their EPS. During the second quarter, 23% of S&P 500 issuers

reduced their year-over-year share count enough to push up their EPS significantly, which compared with 20% of issuers

during first-quarter 2014 and 12% during second-quarter 2013.


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S&P Dow Jones Indices data show that 295 companies reduced their share count in second-quarter 2014, up from 290 in

first-quarter 2014 and 223 in second-quarter 2013. Significant changes (generally considered 1% or greater for the

quarter) continued to strongly favor reductions as 126 issues reduced their share count by at least 1%, which is up from

last quarter's 123 issues and second-quarter 2013's 90 issues. Approximately 116 companies reduced their number of

outstanding shares by at least 4% (second-quarter 2014 over second-quarter 2013), which can be seen in EPS

comparisons, compared with the prior quarter's 99 and second-quarter 2013's 62.

Companies have also continued to increase their total shareholder returns through regular cash dividends along with

buybacks, even as the second quarter's total expenditure declined from the first quarter. Over the year ended June 2014,

combined buyback and dividend expenditures reached a new record high of $865.9 billion, with buybacks representing

61.6% of the total.

If companies wish to continue decreasing their share counts, and therefore increasing EPS, they may need to spend more

on buybacks. The continuing bull market is putting more options in the money. While share count reduction is a

management tool for growing EPS, most companies have a tendency to protect their EPS from dilution by at least covering

their employee issuance.

Table 4

S&P 500 20 Largest Second-Quarter 2014 Buybacks

Company Sector

Q2 2014

buybacks

(mil. $)

12-month

buybacks ending

June 2014 (mil. $)

Indicated

dividend (mil.

$)

SCR

Q2-2014/Q1-2014

(%)

SCR

Q2-2014/Q2-2013

(%)

Apple Informationtechnology

5,000 32,910 11,336 (1.71) (6.46)

InternationalBusinessMachines

Informationtechnology

3,662 19,542 4,454 (3.52) (9.40)

Exxon Mobil Energy 3,003 13,209 11,852 (0.84) (3.07)

Wells Fargo Financials 2,954 7,497 7,374 (0.05) (0.63)

Intel Informationtechnology

2,352 4,009 4,480 0.12 0.33

Home Depot Consumerdiscretionary

2,250 7,700 2,572 (1.67) (6.24)

Merck Health care 2,246 3,824 5,143 (0.74) (2.03)

Express ScriptsHolding

Health care 2,042 5,914 0 (2.53) (7.47)

Oracle Informationtechnology

1,972 9,813 2,140 (0.13) (3.93)

Walt Disney Consumerdiscretionary

1,833 6,480 1,489 (1.24) (4.01)

eBay Informationtechnology

1,657 3,869 0 (0.71) (3.50)

Cisco Systems Informationtechnology

1,533 9,843 3,893 (0.15) (4.87)

Citrix Systems Informationtechnology

1,501 1,806 0 (7.97) (9.34)

Boeing Industrials 1,498 5,799 2,129 (1.94) (4.04)

3M Industrials 1,426 6,351 2,238 (1.47) (4.93)

JPMorgan Chase Financials 1,375 2,800 6,056 (0.29) (0.05)

QUALCOMM Informationtechnology

1,350 6,675 2,836 (0.29) (2.89)


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Table 4

S&P 500 20 Largest Second-Quarter 2014 Buybacks (cont.)

General Dynamic Industrials 1,261 2,946 850 (1.47) (2.86)

The GoldmanSachs Group

Financials 1,250 6,019 984 (1.80) (5.48)

Gilead Sciences Health care 1,200 2,150 0 (0.92) (1.78)

Totals

Top 20 41,365 159,157 69,826

S&P 500 116,171 533,017 356,525

Top 20 percent ofS&P 500 (%)

35.61 29.86 19.59

Q--Quarter. SCR--Share Count Reduction in average weighted diluted share count used for earnings per share. Source: S&P Dow Jones Indices.

On a sector basis, information technology continued to dominate the group even as its share decreased to 26.3% (down

from last quarter's 30.9%) of all S&P 500 buybacks. Apple led the Index with its $5 billion stock repurchase program,

which is down from its record $18 billion expenditure last quarter.

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

Leveraged Commentary And Data: Leveraged Loans Lose 0.6% In September; Year-To-DateReturn Is 2.11%

After gaining 0.15% in August, the S&P/LSTA Leveraged Loan Index fell 0.60% in September, its worst monthly

performance since June 2013.

Loan prices sagged during the month amid heavy market conditions, particularly over the final week of the month, when

the Index slid 0.30%. Moreover, with retail funds selling liquid paper to meet another month of redemptions, the large

loans that constitute the S&P/LSTA Loan 100 lost ground to the broader market, with a 0.96% decline in September. In

August, by contrast, the Loan 100 outperformed, with a 0.24% gain.


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Chart 5

September's setback dropped the year-to-date return for the S&P/LSTA Index to 2.11%, from 2.73% at the end of

August. Likewise, the Loan 100's year-to-date return receded to 1.47% on Sept. 30, from 2.46% a month earlier. By

comparison, the overall Index and Loan 100 were up 3.53% and 3.13%, respectively, during the first nine months of

2013.


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Chart 6

With loans under pressure in September, better-rated paper outperformed. In particular, CCC and defaulted names lagged

single-Bs and BBs. However, that didn't move the needle on year-to-date results, with lower-rated and defaulted loans still

far ahead.

Table 5

Returns By Type Of Debt

August 2014 September 2014 YTD 2014 Average bid

All loans 0.15 (0.60) 2.11 97.51

Performing loans 0.15 (0.55) 2.12 98.27

BB 0.08 (0.52) 1.17 98.62

B 0.18 (0.51) 2.16 98.41

CCC 0.26 (1.07) 6.58 96.03

D 0.42 (3.32) 16.04 70.06

S&P/LSTA 100 0.24 (0.96) 1.47 96.96

YTD--Year-to-date. Source: S&P Capital IQ LCD.

The loan market's mini-swoon in September was a result eroding technical conditions. During the month, the S&P/LSTA

Index grew by an estimated $18.8 billion, to a record $805.2 billion, as M&A-driven institutional loan volume surged by

$30.6 billion, a figure that far surpassed September 2013's total of $21.9 billion on the post-credit-crunch leaderboard.


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Chart 7

Meanwhile, visible capital formation lagged in September, at $3.7 billion, as an estimated $3.1 billion of retail outflows

(according to Lipper and fund filings) offset another robust month of CLO issuance, with managers printing $7.7 billion

of new vehicles.


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Chart 8

These trends explain why loan prices fell in September. The average bid of Index loans, in fact, fell to a 15-month low of

97.51 on Sept. 30, from 98.44 a month earlier.


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Chart 9

What's more, with retail outflows leaving CLOs as the marginal buyers of paper, appetite for par-plus prices has all but

dried up. As of Sept. 30, just 11% of Index loans were trading in triple digits, versus 24% a month prior. In fact, the latest

reading is the lowest since May 2012.


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Chart 10

Looking ahead, participants generally expect volume to track lower in October. On the M&A front, arrangers say there's

a bit of an air pocket after September's rush of deals. Indeed, after reaching a post-credit-crunch high of $49.0 billion in

mid-September, LCD's calendar of M&A loans has retreated to $39.5 billion.

As for demand, managers expect it to remain CLO-heavy. Retail investors, they say, continue to be cautious despite the

recent uptick in rates (see below), while institutional investors continue to put money to work in credit but are focused

more on go-anywhere mandates than on discrete loan allocations.

Thus, the environment remains welcoming for CLOs. For one thing, collateral is cheaper than it has been lately, what with

loan mutual funds less of a factor in the primary market. For another, the same loan mutual funds are providing a steady

stream of secondary supply as they sell to meet redemptions.

All of these factors, players say, suggest that it will be a buyer's market for loans – relatively speaking at least – in both the

primary and secondary over final leg of 2014.

TXU factor: Minus in September, plus year-to-date

In September, defaulted issuer Energy Future Holdings (formerly known as TXU) again exerted an outsized influence on

loan returns, single-handedly subtracting 7.7 bps from the overall Index return. Sans EFH, the Index would have posted a

0.53% loss.


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In the year to date, meanwhile, EFH far and away has been the largest contributor to Index returns, adding 17 bps.

Excluding EFH, the S&P/LSTA Index would be up 1.98%.

Loans versus other asset classes

Loans were hardly the only asset class to feel the pain in September. Risk assets broadly were dented by geopolitical

concerns. As well, expectations for rising rates pushed the 10-year Treasury yield up 17 bps, to 2.52% on Sept. 30, from

2.35% at the end of August, according to the Department of the Treasury. As a result, loans outperformed equities as well

as the three fixed-income categories we track here monthly.

In the year to date, the rate story is the opposite. Since reaching a multiyear high of 3.04% at the end of 2013, the 10-year

rate is down 52 bps. Thus, loans are running last among the asset classes listed here.

Table 6

Returns

September 2014 (%) YTD (%)

S&P/LSTA Index (0.60) 2.11

BAML HY Master (2.10) 3.61

10-year Treasury (1.22) 6.92

S&P 500, including dividends (1.40) 8.18

BAML High-Grade Corp. (1.24) 5.99

YTD--Year-to-date. Sources: S&P Capital IQ LCD and Bank of America Merrill Lynch.

On a risk-adjusted basis, September was not a game changer. Since the inception of the S&P/LSTA Index in January 1997,

loans are trailing high-yield and investment-grade bonds based on their Sharpe ratios, while leading 10-year Treasuries

and equities.

Table 7

January 1997 To September 2014

Annualized returns Standard deviation of monthy returns Sharpe ratio

(%)

S&P/LSTA Index 5.40 1.79 0.48

BAML HY Master (H0A0) 7.77 2.70 0.57

10-year Treasury (GA10) 5.96 2.15 0.47

S&P 500, including dividends (SPX) 8.80 4.55 0.40

BAML High-Grade Corp (C0A0) 6.57 1.56 0.76

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

Big movers

As mentioned above, EFH was the largest detractor to Index returns last month. The other names on the list are a mix of

large, liquid issues such as Clear Channel Communications (now iHeartCommunications) and H.J. Heinz, which got

dinged amid the downdraft, as well as large loans with either sector-related or credit-specific issues, such as Ocean Rig,

Arch Coal, Gymboree, and SeaDrill.

As for the advancers, Toys 'R' Us led the pack, buoyed late in the month by news of its proposed refinancing plan. Toys

was followed by Deluxe Entertainment, which rose on news of a $100 million capital injection from the company's


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sponsors.

Table 8

Big Movers

Standard & Poor's loan rating September index return contribution

(%)

Up

Toys R Us B 0.01

Longview Power D 0.01

Deluxe CCC 0.01

Scientific Games Corp. BB- 0.00

Pierre Foods Inc. B 0.00

Fontainebleau Resorts D 0.00

SkillSoft PLC B- 0.00

Nuveen Investments Inc. B 0.00

Philadelphia Energy Solutions BB- 0.00

American Tire Distributors Inc. CCC+ 0.00

Down

TXU Corp. D (0.08)

Ocean Rig UDW B+ (0.02)

Clear Channel Communications CCC+ (0.02)

Arch Coal Inc. B+ (0.01)

Gymboree Corp. CCC+ (0.01)

SeaDrill Ltd. BB- (0.01)

H.J. Heinz Co. BB (0.01)

Education Management LLC CC (0.01)

Harrah's Entertainment Inc. CCC- (0.01)

Fortescue Metals Group BBB (0.01)

Source: S&P Capital IQ LCD.

Among performing loans, other advancers included Scientific Games and Skillsoft, two issuers that boosted pricing on

their existing loans as they tapped the market for incremental loans for which they needed lender approval.


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Chart 11

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

[email protected]

R2P Corporate Bond Monitor

North America

The U.S. Department of Commerce's latest revision confirmed second-quarter growth of 4.6%, up from the previously

estimated 4.2%. The revision reflected higher exports and business activity. Along with fairly strong employment data

from the past few months, the revision points to a strong third quarter.

September's jobless claims increased; however, the rise was less than expected, which points to a resilient labor market.

The four-week moving average as of Sept. 20, 2014, showed that jobless claims fell 1,250 to 298,500, close to

prerecession levels.

Further economic support came from higher capital goods orders in August. The Department of Commerce said capital

goods, excluding aircraft and defense, rose 0.6% in the month, after falling 0.2% in July. Durable goods drove the

increase, but aircraft and long-lasting goods orders remained volatile.

Business sentiment rose, signaled by rising retail inventories and retail sales. The Department of Commerce reported

inventories had increased 0.4% in July 2014, following a 0.4% increase in June, and retail sales increased 0.6% in August


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(up from a 0.3% gain in July). The improving data trend indicates that consumer spending is strengthening and is a key

indicator of business investment. In a later report, the Department of Commerce also said that consumer spending rose in

August. Purchases rose 0.5% after flat lining in July.

Housing data, however, remains mixed. New home sales reached their highest levels for six years in August, increasing

18% in a second consecutive monthly rise. But new home sales only account for approximately 9% of the housing market,

which also showed weakness in the month through poorer resale figures. The Mortgage Bankers Association (MBA)

announced that applications for mortgages again fell as rates edged higher. Mortgage demand fell 4.1% in the week to

Sept.19, 2014.

Europe

Quantitative easing expectations could increase following banks' low take-up of the European Central Bank's (ECB's)

recent long-term, low-cost loan offering through its Targeted Long Term Refinancing Operation (TLTRO). Furthermore,

September's economic sentiment index deteriorated to 99 from 100.6 in August, according to the European Commission,

as retailer and consumer confidence fell.

According to Eurostat, the eurozone's consumer inflation fell to 0.3% year-on-year in September, down from 0.4%

year-on-year in August, well below the ECB's targeted 2% inflation levels. Inflation remains a major concern in the

eurozone, and the latest figures showed that unprocessed food prices fell 0.9% and energy prices fell 2.4% in the year.

Core inflation dropped to 0.7%, down from 0.9% in August.

The Organization for Economic Cooperation and Development (OECD) urged the ECB to employ stronger measures to

diminish deflationary fears as it cuts its growth forecasts for the currency area. The OECD revised its growth forecasts to

0.8% for the year and 1.1% for 2015, down from 1.2% for 2014 and 1.7% for 2015 in the OECD's May economic

outlook. Therefore, the ECB has urged politicians in the constituent countries to consider structural reforms and policies

to complement the looser monetary policy and aid regional growth.

The eurozone's Purchasing Manager's Index (PMI) data indicated a dip in business activity. The flash composite PMI,

which monitors manufacturing and services activity, showed growth had slowed. The PMI fell to a nine-month low of

52.3 from 52.5 in August. (Any measure above 50 indicates expansion.) The manufacturing PMI fell to 50.5 from 50.7 in

August, and the services PMI dropped to 52.8 from 53.1. Despite PMI figures above the growth threshold of 50, the

composite output price index confirmed that firms continued to cut prices, albeit at a slower pace, with a reading of 49.2

in September, up from 48.9 in August.

Credit Markets

Risk-reward profiles, as measured by average Risk-to-Price (R2P) scores, improved in both the U.S. and in Europe in the

month to Sept. 26, 2014, mainly because of widening spreads in both Europe and the U.S while credit and market risks

remained fairly unchanged.

In North America, option-adjusted spreads (OAS) widened by 28 basis points (bps). The region's average probability of

default (PD) worsened slightly, and the bond price volatility (BP Vol.) remained flat.

In Europe, the average OAS widened by 13 bps. The average PD and BP Vol. both remained flat.

Table 9

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


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Table 9

North American Risk-Reward Profiles By Sector--One-Month Average R2P Score And ComponentsChanges (cont.)

Scores (%) OAS (bps) PD (%) BP Vol (%)

Consumer discretionary (2) 28 0.147 (0.031)

Consumer staples 4 25 0.012 (0.007)

Energy (6) 43 0.100 (0.013)

Financials 11 18 0.001 0.013

Health care 2 29 0.001 0.013

Industrials 2 26 0.055 (0.023)

Information technology (4) 20 0.014 (0.015)

Materials (5) 35 0.081 0.046

Telecommunication services 12 35 (0.001) (0.032)

Utilities 2 21 0.020 0.018

Average 2 28 0.043 (0.003)

OAS--Option-adjusted spread. Bps--basis points. PD--Probability of default. BP Vol.--Bond price volatility. Source: S&P Capital IQ.

Table 10

Europe Risk-Reward Profiles By Sector-- One-Month Average R2P Score And Components Changes

Scores (%) OAS (bps) PD (%) BP Vol (%)

Consumer discretionary 14 9 0.024 (0.007)

Consumer staples (7) 13 0.023 0.048

Energy 15 8 (0.041) (0.023)

Financials 1 8 0.019 0.016

Health care 3 14 0.003 (0.015)

Industrials 11 6 0.044 (0.009)

Information technology (10) 8 0.003 (0.017)

Materials 12 40 0.002 0.035

Telecommunication services (5) 11 0.005 (0.024)

Utilites 8 8 (0.009) (0.005)

Average 4 13 0.007 (0.000)

OAS--Option-adjusted spread. Bps--basis points. PD--Probability of default. BP Vol.--Bond price volatility. Source: S&P Capital IQ.

Fabrice Jaudi, Vice President—Global Markets Intelligence, [email protected]

Kunaal Vora, Credit Research Analyst, London +44(0)207 176 8317; [email protected]

Capital Market Commentary: IPOs, M&A, And Debt

IPOs

The most recent quarter was one of the most active periods for IPO underwriting in the past few years. During the

quarter, 49 companies priced new securities in the U.S. market, led by Chinese e-commerce company Alibaba Group

Holding Ltd.'s $21.8 billion issue. In terms of performance, more than one-third of the IPOs that came to market last

quarter have gained more than 10% from their original offer price, according to the S&P Capital IQ database. However,

when we examine all IPO activity to date, we find that nine issues have gained 100% or more from their original offer

price. Leading the way is consumer products firm GoPro Inc., which has seen its share price leap 275% since its June


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debut in a $427.2 million offering. Among the nine issues highlighted below, four are in the health care sector.

Table 11

Top IPO Gainers In 2014*

Date Issuer Price per share ($) Recent price (Latest) ($) Change (%)

6/25/2014 GoPro Inc. 24 90.20 275.8

9/11/2014 ReWalk Robotics Ltd. 12 32.95 174.6

6/5/2014 Radius Health Inc. 8 21.15 164.4

1/30/2014 Ultragenyx Pharmaceutical Inc. 21 54.88 161.3

5/14/2014 Zendesk Inc. 9 21.54 139.3

7/24/2014 El Pollo Loco Holdings Inc. 15 34.59 130.6

2/4/2014 Auspex Pharmaceuticals Inc. 12 25.74 114.5

7/31/2014 Mobileye N.V. 25 50.29 101.2

6/17/2014 ZS Pharma Inc. 18 36.15 100.8

*Year-to-date. Source: S&P Capital IQ.

M&A

The board of eBay Inc. has announced that the company intends to spin off its online payment operator PayPal Inc. as a

separate, publicly-traded company. This represents the most recent example of a company breaking itself up to advance

shareholder value, an increasingly common trend in today's market (the actual distribution is not expected to occur until

sometime in 2015). So far this year 17 companies have completed spin-off distributions (those with transaction values

greater than $1 billion are highlighted below in table 12), which is up from nine distributions in all of 2013, according to

S&P Capital IQ data. The Global Markets Intelligence (GMI) research unit of S&P Capital IQ finds that this year has

been one of the busiest years for spin-off distributions since 24 spin-offs were completed in 2008. The largest completed

spin-off this year involved student loan company SLM Corp. spinning off its loan servicing operations into Navient Corp.,

leaving SLM to operate as a consumer bank. Since the issue's distribution, Navient Corp. shares have advanced by about

5%.

Table 12

Largest Spin-Off Distributions In 2014*

Announced

Spin-off distribution record

date Target

Total transaction value

(mil. $) Sellers

5/29/2013 4/22/2014 Navient Corp. 11,427.30 SLM Corp.

12/10/2013 6/30/2014 Northstar Asset ManagementGroup Inc.

4,521.60 NorthStar Realty FinanceCorp.

9/24/2013 5/22/2014 NOW Inc. 3,356.00 National Oilwell Varco Inc.

12/13/2013 5/16/2014 Washington Prime Group Inc. 3,253.80 Simon Property Group Inc.

5/23/2013 2/19/2014 Knowles Corp. 2,554.60 Dover Corp.

9/5/2013 6/23/2014 TimkenSteel Corp. 1,802.70 Timken Co.

1/27/2014 6/18/2014 Rayonier Advanced Materials Inc. 1,556.70 Rayonier Inc.

10/10/2013 8/21/2014 Liberty TripAdvisor Holdings Inc. 1,381.30 Liberty Interactive Corp.

3/17/2014 6/19/2014 Seventy Seven Energy Inc. 1,104.00 Chesapeake Energy Corp.

2/20/2014 4/3/2014 Blackhawk Network Holdings Inc. 1,061.40 Safeway Inc.

12/6/2013 3/24/2014 Lands' End Inc. 1,018.20 Sears Holdings Corp.

*Year-to-date. Source: S&P Capital IQ


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Debt

We saw mixed results in September as three of the six regularly surveyed debt asset classes (see table 13) saw a decline in

their number of CUSIP orders. However, when we look at the full month's results, we see that there was actually a 1.3%

gain in overall identifier demand. Domestic corporate debt identifier demand rose to 745 from 677 in August. Despite the

increase, the past month's results represent the third-lowest monthly count for domestic corporate debt identifier orders

this year. Municipal CUSIP requests fell to 896 last month after four straight months over the 1,000 level. Furthermore,

the past month's activity marks the slowest period for municipal CUSIP orders since March 2014 when 865 CUSIPs were

sought. On the other hand, CUSIP requests for forthcoming international debt securities exceeded the 300 mark, reaching

302 orders processed. That result marks the highest level of identifier demand for that security class that we have ever

seen.

Table 13

Selected Debt Issues CUSIP Requests

September August 2014* 2013* Change (%)

Domestic corporate debt 745 677 7,330 7,969 (8.0)

Municipals 896 1,084 9,000 10,287 (12.5)

Short-term municipal note 141 178 1,104 1,075 2.7

Long-term municipal note 46 65 485 504 (3.8)

International debt 302 167 2,103 1,622 29.7

PPN domestic debt 269 198 1,727 1,763 (2.0)

Total 2,399 2,369 21,749 23,220 (6.3)

*Year-to-date. Source: CUSIP Global Services.

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

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

S&P Capital IQ Research & Analytics


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