Decoupling talk is back in vogue. We are disinclined to believe that markets can truly diverge in the event of a European credit contraction; however, there is little doubt that U.S. economic data have supported U.S. markets and frustrated traders expecting another shoe to drop.

Since the late October rally, the performance of the S&P 500 has diverged from many of its global peers, notably outstripping the Korean KOSPI, a proxy for global growth. In our view, this has been warranted by the relative improvement in US macro data and resilient S&P 500 earnings. Indeed, the Barclays Capital FX Surprise Indices have also diverged; the US continues to surprise to the upside, while Europe, the UK and the G7 have disappointed. It is not surprising that U.S. equities have led not only European stocks, but also EM markets leveraged to global growth.

The outlook for S&P 500 companies is showing signs of stabilization; strong results and commentary from the corporate sector have helped the market counterbalance the deterioration overseas. After resetting expectations following 2Q11 earnings season, S&P 500 companies solidly beat 3Q11 estimates by 6.1%, or 3.5% ex-financials and energy.

One key element in our decision to temper our bullish call for equities for 4Q11 (1325 to 1260) was the sharp drop in 2012 earnings expectations. We expected the implied growth rate to fall toward our 6% forecast; although it did fall from 16% to 11%, the leading indicator for the direction of earnings estimates (net revisions) and the expected growth rate are, for now, showing signs of stabilization. Given that we are halfway through 4Q11 and the incoming macroeconomic data have been at least as strong as in late 3Q11, it seems unlikely that the domestic data will be the catalyst for another round of analyst estimate cuts. Still, the obvious risk to the global growth outlook and S&P 500 earnings is the trend in European GDP forecasts and its effect on global estimates. Next week brings the flash November PMI estimates for Germany, France and the eurozone, which could certainly trigger another round of cuts in estimates for global growth-leveraged sectors such as industrials, technology and energy. In light of the decent data in the U.S, we do not expect as sharp a drop as the $5 hit to 2012 estimates this fall, but we believe the 2012 growth rate is still too high. 

In the near term, the trends in U.S. macro data and the stabilization in S&P 500 earnings should help mitigate overseas concerns. However, further out, we are not as sanguine and expect a tough stretch for U.S. equities beginning in 1Q12. Global growth worries should remain on the forefront, and public policy concerns heading into election season should put upward pressure on equity risk premiums. Until then, we see symmetrical risks for U.S. equities, with a bias to the upside.



source: BarCap