An Ugly Earnings Picture

4/18/2016


The numbers don't look good. According to a blend of actual results and estimates compiled by Thomson Reuters, the S&P 500 Index's profits are expected to be down 7.8% for the first quarter. At the start of the quarter, analysts expected a 2.3% gain.

Of course, profit estimates falling during a quarter is nothing new. We've seen it every quarter since early 2011. But during the last 20 quarters, estimated growth declined an average of about five percentage points between the start of the quarter and 12 days after the end of the quarter, right before earnings season picks up. This year's decline topped 10 percentage points, by far the sharpest drop in at least five years. 

Analysts' pessimism regarding estimates seems appropriate, given the following earnings-related trends:

• A decline in the S&P 500's first-quarter profits would mark the first streak of four consecutive quarters with year-to-year declines since 2009.

• Among the 135 companies that have issued earnings preannouncements for the third quarter, negative announcements (103) outnumber positives (27) by a ratio of 3.8-to-1, well above the long-run average of 2.7-to-1.

• Only three of the index's 10 sectors — consumer discretionary, telecom, and health care — are expected to report higher first-quarter profits. The consensus called for the energy sector to swing to a loss from a profit a year earlier. 

We shared these numbers with you because knowledge makes for better investment decisions — even if that knowledge tells a dismal tale. Fortunately, this story is far from over.

Not all bad

Before you worry too much, consider these three points:

1) Stocks have bounced in recent weeks, despite the continued erosion in earnings estimates. This rally illustrates a fact no investor should forget: Stocks can, and often do, move in opposition to expectations for corporate profits.

2) While operating results matter, stocks' reactions to those results matter more. Pay particular attention to how companies guide expectations for the year ahead.

3) Earnings season can reboot a market. As of April 13, only 27 stocks in the S&P 500 had reported first-quarter earnings, which leaves a lot unsaid. The dam will start to break next week.

Our recommended lists have 21% to 22% invested in a short-term bond fund, a weighting that could shift in either direction, depending on how investors respond to earnings news. The Industrials have pulled within 0.1% and the Transports within 4.1% of their November highs. Closes in both averages above those highs might not turn the Dow Theory bullish, but probably would drive us to deploy some cash.


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