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Key Points:

• 4Q earnings season finished, first quarter season starting. So far 26 (5.2%) reports in. Median surprise of 2.86% and surprise ratio of 5.67 for EPS, 0.81% and 2.83 for revenues. Strong growth of 22.7% (14.6% ex-Financials) reported, but big slowdown expected for the vast majority yet to report. Just 7.71% (9.29% ex-Financials), down from the 30.8% (19.8%) those firms reported in the 4Q.
• Quarterly net margins reported rise to 7.92% from 7.06% a year ago, up from 7.06% in fourth quarter. Margins excluding financials rise to 7.62% from 6.85% last year and 7.30% in fourth quarter. Expectations for yet-to-report firms for margins to rise to 9.03% from 8.73% a year ago, 8.92% in 4th quarter.
• Full-year total earnings for the S&P 500 jumps 45.3% in 2010, expected to rise 15.1% further in 2011. Growth to continue in 2012 with total net income expected to rise 13.9%. Financials the major earnings driver. Excluding Financials, growth was 27.4% in 2010, and expected to be 13.9% in 2011 and 12.0% in 2012.
• Total revenues for the S&P 500 rise 8.18% in 2010, expected to be up 3.90% in 2011, and 5.95% in 2012. Excluding Financials, revenues up 9.70% in 2010, expected to rise 7.33% in 2011 and 6.07% in 2012. 
• Annual Net Margins marching higher, from 5.88% in 2008 to 6.39% in 2009 to 8.59% for 2010, 9.50% expected for 2011 and 10.21% in 2012.
• Major source of earnings growth. Net margins ex-Financials 7.79% in 2008, 7.08% in 2009, 8.22% for 2010, 8.82% expected in 2011, and 9.31% in 2012.
• Revisions ratio for full S&P 500 at 1.32 for 2011, at 1.74 for 2012, both bullish readings. Ratio of firms with rising-to-falling mean estimates at 1.32 for 2011, 1.53 for 2012, also very positive readings. Total revisions activity passing seasonal low.
• S&P 500 earned $545.1 billion in 2009, rising to $790.4 billion in 2010, expected to climb to $909.5 billion in 2011. In 2012, the 500 are collectively expected to earn $1.036 Trillion.
• S&P 500 earned $57.13 in 2009, $83.16 in 2010 and $95.67 in 2011 expected bottom up. For 2012, $109.02 expected. Puts P/Es at 16.06x for 2010, and 13.96x for 2011 and 12.25x for 2012, very attractive relative to 10-year T-note rate of 3.54%.
• Top-down estimates, $92.70 for 2011 and $98.93 for 2012.

Earnings Season Now Underway

The fourth quarter earnings season is over, and now the focus turns to the first quarter. While it “officially” kicks off after the bell today when Alcoa (AA) reports, we already have 26 (5.2%) first quarter reports in from the S&P 500.

Alcoa, though, like the Master’s -- is but the first of the majors. It will not be the only one in the early going. We will also hear from Google (GOOG), J.P. Morgan (JPM) and Bank of America (BAC) this week. Together, they should provide some good clues to the overall direction of earnings season.

One firm which is not a household name but we be good to keep an eye on is Fastenal (FAST). It is the number one maker of fasteners -- things like screws and bolts -- which go into all sorts of other things. If it reports strong results, it is a good bet that the rest of the market will, as well.

Good Start, but Earnings Growth to Slow

While far too early to draw any conclusions, it looks like we are off to a good start on the first quarter, with reported net income growth of 22.7%, down just slightly from the 25.7% growth those same 26 firms reported in the fourth quarter. That, however, is not expected to last. The consensus is looking for a dramatic slowdown in growth for the remaining firms, with total net income rising just 7.71%.

Financial firms setting aside much less than a year ago for bad debts were a big part of the earnings story for the fourth quarter, and a big part of the deceleration in year-over-year growth has to do with a much higher base, particularly in the Financials in the first quarter of 2010 than in the fourth quarter of 2009. If the Financial sector is excluded, total net income rose 19.8% from a year ago, in the fourth quarter, and in the first quarter it is expected to slow to 9.3%.

Positive Surprises Expected?

Given the trend of positive earnings surprises, I would be shocked if the actual growth rate is that low. It is almost certain to be in the double digits again. Revenue growth in the fourth quarter was healthy at 8.28%. Looking ahead to the first quarter, though, those firms yet to report are expected to post year-over-year revenue growth of just 4.14%.

Financials are the key reason for the slowdown in revenue growth; if they are excluded, reported revenue growth is expected to be 9.08%. Tougher year-over-year comparisons are a big part of the story.

Net Margins to Expand Slightly

Net margin expansion has been a driver of earnings growth, but that expansion is slowing down, particularly if one excludes the Financials. Overall, net margins are expected to come in at 9.03% in the first quarter, up from 8.73% a year ago, and from 8.92% in the fourth quarter.  However, excluding the Financials, net margins are expected to only creep up to 8.29% from 8.27% a year ago, and down from 8.81% in the fourth quarter.

Among the handful of S&P 500 companies that have already reported for the first quarter, overall net margins are 7.92%, up sharply from 7.06% a year ago and from 7.06% in the fourth quarter. Strip away the Financials that have already reported and the picture is different, rising to 7.62% from 7.86% a year ago and from the 7.30% reported in the fourth quarter.

Do not make too much of the level of reported net margins being significantly lower than the expected net margins. That is due to the reporting firms being very overweighted towards retailers (many have February fiscal period ends), which tend to be lower-margin businesses.
 
On an annual basis, net margins continue to march northward. In 2008, overall net margins were just 5.88%, rising to 6.39% in 2009. They hit 8.59% in 2010 and are expected to continue climbing to 9.59% in 2011 and 10.31% in 2012.  The pattern is a bit different, particularly during the recession, if the Financials are excluded, as margins fell from 7.78% in 2008 to 7.09% in 2009, but have started a robust recovery and rose to 8.24% in 2010.  They are expected to rise to 8.84% in 2011 and 9.37% in 2012.

Another Good Year Overall?

The expectations for the full year are very healthy, with total net income for 2010 rising to $790.5 billion in 2010, up from $545.1 billion in 2009. In 2011, the total net income for the S&P 500 should be $909.5 billion, or increases of 45.3% and 15.1%, respectively. The expectation is for 2012 to have total net income passing the $1 Trillion mark to 1.036 Trillion.

That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $108.50. That is up from $57.13 for 2009, $83.16 for 2010, and $95.67 for 2011. In an environment where the 10-year T-note is yielding 3.54%, a P/E of 16.1 based on 2010 and 14.0x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is 12.3x.

With far more estimates being raised than being cut (revisions ratio of 1.32), one has to feel confident that the current expectations for 2011 will be hit, and more likely exceeded. Analysts are raising their 2012 projections at an even higher rate, with a revisions ratio of 1.74. While a lot can happen between now and the time the 2012 earnings are all in, upward estimate momentum means that the current 2012 earnings are more likely to be exceeded than for them to fall short.

This provides a strong fundamental backing for the market to continue to move higher. The fact we are in the third year of the presidential cycle (almost always the best of the four, and by a big margin). We have a Democrat in the White House, which has historically meant good things for the stock market, with an average annualized return over the last 50 years more than triple that when the GOP holds the Oval Office. Few, if any, binomial variables have as much statistical significance. Those factors should combine to make this a good year for the market.

Government Not Shutdown - But At What Cost?
 
That does not mean that all is smooth sailing ahead. We managed to avoid a government shutdown, but only at the cost of large spending cuts that will slow the economy. Those should probably shave at least a half point off of the growth we would have had in 2011, and probably result in hundreds of thousands of fewer jobs being created.  

The lower growth will result in lower tax collections, so the impact on the budget deficit will be much less than the amount advertised. Job creation remains sluggish, but is starting to show signs of picking up. We created 230,000 jobs in the private sector in March, down from 240,000 in February, but that is after a big upward revision to the February numbers.

However, State and Local governments laid off a total of 15,000 people for the month, on top of 46,000 pink slips the month before. Those jobs count just like private sector jobs, and are a major headwind to bringing down the total number of unemployed. The idea that one can reduce unemployment by cutting jobs is positively Orwellian, and it is hard to believe the advocates of this message are taken so seriously.

The household survey has been much more upbeat, showing growth of 291,000 jobs in March, on top of 250,000 gained the month before. The unemployment rate fell to 8.8%, and it was as high as 9.8% as recently as November.

International Headwinds Remain

The international situation clearly has the potential to abort the recovery as well. The disaster in Japan will clearly slow its economy dramatically in the first quarter, although much of that growth will be made up later in the year as the reconstruction process gets underway. Many U.S. products have parts that are made in Japan, and that is likely to disrupt production here.

The turmoil in the Middle East is not going away, and that is likely to keep oil prices both high and volatile. High oil prices will also act as a depressing force on the economy. It is worth noting that many of the S&P 500 firms seeing the largest increases for this year’s earnings are oil companies. Owning some oil company shares can be a great hedge for rising prices at the pump.

The debt crisis in Europe is not going away with Portugal now also getting bailed out, even as the ECB makes life tougher on the PIIGS by raising rates. On the plus side, the dollar has been weak, and that should improve the trade deficit, particularly the non-oil side, and that will be a significant positive for the economy.

It also means that the foreign operations of U.S. companies will be much more profitable when the results are measured in dollars. Inflation, other than in food and energy, is well contained, and that should let the Fed stay on Easy Street as far as monetary policy is concerned.

Scorecard & Earnings Surprise

• Fourth quarter season done, and the first quarter season starting. So far, 26 (5.2%) of S&P 500 reports in. Off to a strong start, with year-over-year growth of 22.7% -- a 5.67 surprise ratio, and 2.86% median surprise. The fourth quarter was a somewhat better than “normal” earnings season: 30.7% year-over-year growth, median surprise of 3.61%, and a 3.14 surprise ratio (345 beats, 110 misses). 69.0% of all firms beat expectations.
• Positive year-over-year growth for 23 firms, falling EPS for 3 -- a 7.67 ratio; 88.5% of all firms reporting have higher EPS than last year.
• Very early -- the percentages and ratios will change dramatically over next few weeks.
• In 4Q, Energy and Materials led in surprises, but Autos, Conglomerates and Tech also had median surprises of over 6%; Transportation, Utilities and Construction relatively disappointing.

Historically, a “normal earnings season” will have a surprise ratio of about 3:1 and a median surprise of about 3.0%. Thus in the early going we are doing much better than average on the median front, and about average on the ratio front. Early on the ratios and medians can be very volatile, but it looks like an OK start to things. Pay attention to the percent reporting in evaluating the significance of the sector numbers.

Scorecard & Earnings Surprise 4Q Reported
Income Surprises	Yr/Yr Growth	% Reported	Surprise Median	EPS Surp Pos	EPS Surp Neg	# Grow Pos	# Grow Neg
Finance	481.15%	1.28%	58.49	1	0	1	0
Industrial Products	20.41%	4.76%	13.89	1	0	1	0
Consumer Discretionary	2.40%	6.25%	8.36	1	1	1	1
Consumer Staples	11.61%	11.11%	6.17	3	0	4	0
Computer and Tech	25.86%	8.33%	4.26	4	1	5	1
Business Service	6.50%	5.26%	2.86	1	0	1	0
Retail/Wholesale	10.80%	18.18%	2.07	5	0	8	0
Basic Materials	7.64%	4.35%	1.63	1	0	1	0
Construction	-57.14%	9.09%	0.00	0	0	0	1
Transportation	7.11%	11.11%	-1.22	0	1	1	0
Medical	NA	NA	NA	NA	NA	NA	NA
Auto	NA	NA	NA	NA	NA	NA	NA
Conglomerates	NA	NA	NA	NA	NA	NA	NA
Aerospace	NA	NA	NA	NA	NA	NA	NA
Oils and Energy	NA	NA	NA	NA	NA	NA	NA
Utilities	NA	NA	NA	NA	NA	NA	NA
S&P 500	22.73%	5.20%	2.86	17	3	23	3

Sales Surprises

• Strong revenue start, revenue growth of 9.50% among the 26 that have reported, median surprise 0.77%, surprise ratio of 2.71. In 4Q, sales surprise ratio at 1.88, median surprise 0.96%, a strong showing, 64.8% of all firms did better than expected on top line.
• Growing Revenues outnumber falling revenues by ratio of 5.50, 84.6% have higher sales than last year, in the 4Q, ratio of 3.46, 77.4% of firms had higher revenues than a year ago.
• In 4Q, Conglomerates and Materials lead in sales surprise. Industrials, Tech, Discretionary and Finance also posting better-than-expected top lines. Utilities and Transports disappoint.
• Revenue growth healthy in 4Q at 7.09%, but still greatly lagged earnings growth, pointing to net margin expansion (see net margin tables below).

Sales Surprises
Sales Surprises	Yr/Yr Growth	% Reported	Surprise Median	Sales Surp Pos	Sales Surp Neg	# Grow Pos	# Grow Neg
Finance	0.41%	1.28%	24.198	1	0	1	0
Construction	-2.79%	9.09%	7.787	1	0	0	1
Industrial Products	8.82%	4.76%	3.142	1	0	1	0
Computer and Tech	29.56%	8.33%	1.08	5	1	5	1
Retail/Wholesale	7.22%	18.18%	1.069	6	2	7	1
Business Service	4.53%	5.26%	0.716	1	0	1	0
Transportation	11.06%	11.11%	0.715	1	0	1	0
Consumer Discretionary	5.60%	6.25%	0.204	1	1	1	1
Basic Materials	6.14%	4.35%	0.028	1	0	1	0
Consumer Staples	1.22%	11.11%	-1.821	1	3	4	0
Medical	NA	NA	NA	NA	NA	NA	NA
Auto	NA	NA	NA	NA	NA	NA	NA
Conglomerates	NA	NA	NA	NA	NA	NA	NA
Aerospace	NA	NA	NA	NA	NA	NA	NA
Oils and Energy	NA	NA	NA	NA	NA	NA	NA
Utilities	NA	NA	NA	NA	NA	NA	NA
S&P 500	9.50%	5.20%	0.765	19	7	22	4

Reported Quarterly Growth: Total Net Income

• The total net income is 22.7% above what was reported in the first quarter of 2010, down from 25.7% growth the same 26 firms reported in the fourth quarter. In the fourth quarter, full S&P total growth was 30.7%; growth excluding Financials 19.9%.
• Sequential earnings growth is 21.6% for the 26 that have reported.
• For full S&P in 4Q, massive growth for Financials, mostly due to lower loss provisions; earnings quality questionable. Industrials, Materials and Energy all reported over 40% growth.
• Still to early to draw any conclusions -- six sectors with no reports in at all, six more with only a single firm reporting.

Quarterly Growth: Total Net Income Reported
Income Growth	"Sequential Q2/Q1 E"	"Sequential Q1/Q4 A"	Year over Year 1Q 11 A	Year over Year 2Q 11 E	Year over Year 4Q 10 A
Construction	211.98%	+ to -	- to -	-69.20%	- to +
Finance	-26.48%	32.86%	- to +	84.79%	306.98%
Computer and Tech	30.67%	-3.65%	25.86%	9.15%	39.90%
Industrial Products	6.88%	5.36%	20.41%	16.78%	-6.67%
Consumer Staples	-6.83%	-24.49%	11.61%	14.15%	-1.41%
Retail/Wholesale	-33.96%	57.29%	10.80%	10.98%	15.00%
Basic Materials	-41.96%	10040.00%	7.64%	32.54%	- to +
Transportation	114.12%	-9.54%	7.11%	30.82%	-17.97%
Business Service	-9.44%	-2.24%	6.50%	2.27%	6.35%
Consumer Discretionary	16.16%	-7.90%	2.40%	-5.39%	15.23%
Medical	Na	Na	Na	Na	Na
Auto	Na	Na	Na	Na	Na
Conglomerates	Na	Na	Na	Na	Na
Aerospace	Na	Na	Na	Na	Na
Oils and Energy	Na	Na	Na	Na	Na
Utilities	Na	Na	Na	Na	Na
S&P	-1.56%	21.55%	22.73%	12.22%	25.71%
Excluding Financials	12.61%	20.99%	14.56%	24.70%	21.58%

Expected Quarterly Growth: Total Net Income

• Total net income growth for the vast majority (474 firms) yet to report expected to slow dramatically, to just 7.7% year over year from 30.8% in the 4Q. Sequentially net income expected to be 4.6% lower.
• Much of the slowdown due to much higher Financial earnings in 1Q10 than in 4Q09, causing Financial year-over-year growth to plunge to just 1.4% from massive 4Q growth of 164.5%, even as Financial earnings grow 16.4% sequentially. Total growth ex-Financials to slow to 9.3% from 19.8%.
• Industrials, Materials, Transports and Energy all expected to post over 20% growth.
• Four sectors expected to post year-over-year total net income declines; Construction very weak.
• Eight sectors expected to post double-digit sequential declines.

Quarterly Growth: Total Net Income Expected
Income Growth	Sequential Q2/Q1 E	Sequential Q1/Q4 E	Year over Year 1Q 11 E	Year over Year 2Q 11 E	Year over Year 4Q 10 A
Industrial Products	21.34%	1.69%	46.64%	23.94%	66.38%
Basic Materials	8.20%	23.06%	23.74%	32.26%	47.68%
Transportation	32.46%	-19.63%	22.82%	14.57%	38.41%
Oils and Energy	9.86%	2.76%	21.81%	18.23%	40.47%
Conglomerates	22.01%	-28.55%	18.64%	16.38%	33.57%
Business Service	7.53%	-7.03%	13.83%	14.38%	16.56%
Computer and Tech	4.40%	-20.23%	13.16%	11.10%	25.11%
Consumer Discretionary	22.00%	-16.77%	8.09%	26.09%	22.56%
Auto	23.38%	27.00%	7.20%	-1.69%	-4.40%
Retail/Wholesale	11.20%	-25.61%	6.34%	7.98%	11.56%
Finance	6.62%	16.36%	1.39%	9.17%	164.48%
Aerospace	12.16%	-19.96%	0.86%	-4.75%	-2.87%
Consumer Staples	18.27%	-11.97%	-0.66%	5.52%	7.71%
Medical	4.43%	1.15%	-2.11%	1.16%	7.90%
Utilities	-6.72%	21.54%	-2.74%	-2.86%	1.02%
Construction	175.71%	-25.20%	-17.44%	3.75%	-1.79%
S&P	8.93%	-4.57%	7.71%	9.91%	30.83%
Ex Financials	9.46%	-8.38%	9.29%	10.08%	19.82%

Quarterly Growth: Total Revenues Reported

• Revenue growth strong at 9.50%, down from the 9.87% growth posted (26 firms) in the fourth quarter. Sequentially, revenues 8.37% higher than in the fourth quarter.
• Still very early, most of the attention should be on the yet-to-report tables.

Quarterly Growth: Total Revenues Reported
Sales Growth	"Sequential Q1/Q4 E"	"Sequential Q4/Q3 A"	Year over Year 1Q 11 A	Year over Year