As we pass the halfway mark for earnings, three themes are emerging:
1) Third quarter earnings growth is improving from the start of the month. Growth is at 4.5 percent with 67 percent beating expectations, above the historic average of 62 percent beating. Revenue growth is at 4 percent, with 51 percent beating, below the historic average.
2) Market rotation remains the main story this year; stocks have done well because different sectors have assumed leadership at different times of the year.
After several quarters where financials led, non-financials are poised for a fairly good quarter. There is a slightly more defensive tone to the market this quarter: Since October, defensive names (Telecom, Consumer Staples, and Utilities) have all outperformed the S&P 500; but so have industrial names and the materials sector.
Financials, which have been the marker leader in earlier quarters, are performing in-line. Energy, Healthcare and Tech, which have also been market leaders at various times this year, are lagging.
3) Small caps continue to outperform large caps, for the quarter and the year. The S&P Small Cap 600 Index is up 33.5 percent his year, far outperforming the 23.4 percent gain of the S&P 500. This out-performance is a sign that the economy is slowly improving.
My biggest concern for the markets is a simple one: reversion to mean. The historic average gain in the S&P 500 (excluding dividends) is roughly 6 to 7 percent, but we have had double digit growth in four of the last five years:
S&P 500 returns (not including dividends)
2013 (YTD): 22.3%
True, we had a huge drop of almost 50 percent around 2008, but that's my point: it's reverting to the mean. Is it reasonable to expect another year of double digit gains in 2014?
Let's assume the S&P ends the year right where it is now, around 1,760. A 10 percent gain in 2014 would put it at 1,936. That is about the middle ground of what some strategists are estimating.
Here's why: Right now earnings for 2013 are around $108. A modest 7 percent increase in earnings would put it at $115 for 2014. Assuming the current multiple of roughly 15.5 times earnings puts the S&P at 1,782 ($115 x 15.5). That's only about 20 points from where the S&P is right now.
But a lot of people are talking about much higher numbers. Let's assume earnings of $122, and that the economy picks up, expanding at a minimum 3 percent GDP rate. You could make an argument for an expanded multiple to, say, 17. In that case the S&P could go to 2,074 ($122 x 17).
That's a big difference: 1,782 on the lower end, 2,074 on the high end. The middle ground is 1,928--almost exactly a 10 percent increase.
1) earnings: Floor and ceiling maker Armstrong World Industries beat modestly on bottom line, but revenues were light (where have we heard this before?). The company lowered the high end of it 2013 earnings and revenue guidance as commercial construction activity flatten out in the US and Europe.
—By CNBC's Bob Pisani