• The version of the word that means “Depressed, or ill-humor” seems to come from a Scottish root word and earlier from the Flemish.  First usage dates to the 1700s.
• Smelling “Funky” relates to cheese and is, predictably, of French origin.  It is this version which some word scholars claim for the origin of the musical term, perhaps is an indication of the sweat and effort required to play with intensity and feeling.

No matter the source, I can tell you that Wall Street analysts are currently in a funk over what they see coming down the road for third and fourth quarter revenue growth.  Whether than means they are depressed or malodorous is beyond the scope of this brief note.  But the numbers speak for themselves:
 

• Back in April the analysts that cover the 30 companies of the Dow Jones Industrial Average were showing their clients financials models which predicted that Q3 2012 would be a solid period of top-line growth – somewhere between 3-4%.  The faster growth would come from the non-financial companies of the Dow, where revenue comps would be over 4% versus prior year.
• As we close out the final days the same third quarter, those same models from those same analysts now show outright declines in expected revenues from the prior year.  The average for all 30 companies is now (0.6%), and the non-financial names are expected to essentially flat to last year, down 0.2%.  Global inflation is still positive, remember, so this slip in top line growth indicates an outright contraction in unit volume demand and/or a meaningful slip in product mix.
• These same analysts are still cutting their expectations for revenue growth for Q4 2012 and Q1 2013.  These comps are still (or for the moment) in positive territory.  Wall Street expects Q4 to post a 2.8% average rate of revenue growth for the Dow companies, and +2.9% for the non-financial names in the index.  This is still a big haircut, however, from the 6-7% comp expectations of April 2012.  For the first quarter of 2013, analysts currently show a 3-4% expected growth rate versus Q1 2012. Again, that is substantially lower than the 5-6% expectations from their models of May 2012.
• As it stands right now, therefore, sell-side analysts seem to expect Q3 2012 to be the “Trough” for revenue growth – a short dip followed by a resumption of expansion into next year.  Whether that holds will come down to two catalysts.  The first is what companies have to say about their current business conditions when they report earnings next month.  The second will be what happens when analysts really pull out the pencil and work through their quarterly estimates for next year.  Up to now, those numbers have been more placeholders than well considered and vetted estimates.

Of course, what really matter if far more simple: U.S. stocks have rallied from 1280 on the S&P 500 to just over 1430, even as analysts have been busy hammering away at their expectations for revenue growth.  Not even the realization that large, well run companies with global footprints are unable to increase revenues has been enough to stop the rally.  How many Wall Street strategists told investors “Buy stocks because it will soon become apparent that scores of iconic American companies will make fewer sales than last year?”  To borrow from the funk theme at the top of this note, about as many as know who Curtis Mayfield was, I suspect.  Revenue estimates aren’t about to “Move on Up” – that’s for sure.

So we are left with a few choices to explain this market anomaly, and this is an important exercise.  What is clear is that “Micro” fundamentals have proven irrelevant to the big market moves of the last four months.  So what is important? A few ideas:

• Earnings power.  Revenue growth is the proof that a company has an edge in its market.  Taken as a whole, as we do here, it is a crude but effective proxy for future economic expansion.  Technically, however, stocks discount earnings rather than sales.  And there is no doubt that earnings have held up very well as U.S. corporations have kept a weather eye on costs.  Another reason why earnings season will be so critical to stocks – U.S. companies are on a ragged edge when it comes to making their numbers as incremental sales fail to materialize.
• Macro trumps micro.  The other missing piece of the U.S. stock market puzzle is what valuation should investors award to forward earnings.  Earnings expectations have been fairly stable this year, at $90-105 per S&P 500 share, so much of the gyration over this period have a lot to do with whether those bottom line results are worth 12x or 15x on a price-earnings basis.  Now that the European Central Bank has outlined what it plans to do to ameliorate the ongoing sovereign debt crisis and the U.S. Federal Reserve is at the brink of another round of bond-buying, it could well be that markets feel more comfortable at the top end of that range.
• The bad news was actually factored in some time last year.  Yes, the S&P 500 is up 23.6% over the last year.  But remember that it treaded water for the second half of 2011, fretting over the Greek debt crisis and the U.S. debt limit debate.  Perhaps this was when the market actually reconciled itself to a lousy set of company fundamentals for much of 2012.  Markets, after all, discount the future.

The logical place to close out this note is with an assessment of how long the current market rally can last, and especially if it has legs through the fourth quarter.  The short, and funky, answer is a John Shaft-like “Right on.”  Sorry – more Curtis Mayfield.  Here’s why:

• Earnings may not have the visibility of incremental revenues, as we’ve shown, but barring a financial markets meltdown or long-shadowed global geopolitical problem they are still “Solid.”  And let’s not forget that U.S. companies are right back at “Peak” earnings from the last expansion before the Financial Crisis without the benefit of a strong economy.
• The fourth quarter has a whole series of challenges – the Fiscal Cliff, a new debate on the Federal Debt Limit (both in the US) and a still-deteriorating set of European economies.  Oh, and the U.S. elections.  But no one really expects a lame duck Congress to do anything controversial, so all the long-dated problems that bears are rightly focused on will not see the light of day until 2013.
• The Federal Reserve will keep providing liquidity into 2013, and the ECB is just getting started. 

In short, there is room for the current rally to carry through into the fourth quarter.  Don’t get me wrong – there are a host of structural problems that will come home to roost.  This market is “Funky,” to say the least.  Whether that means you want to dance to it, or hold your nose, is really up to what time frame you have in mind.

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