EARNINGS UPDATE: DID WE JUST TROUGH?
Earnings season is long over and investors are already beginning to look at Q2 earnings for the next market catalyst. Analysts currently expect Q2 earnings to fall 36%. Analysts have raised their 2009 earnings expectations for the first time this year to $57. A very important trend is occurring in corporate earnings. As the economy and earnings appear to be seeing some signs of stabilizing the estimates are remaining low. I’ve attached my proprietary expectation ratio below. This ratio calculates how real earnings expectations compare to analysts expectations. It is a leading indicator, turned negative in 2007 and turned positive for the first time in Q4 of 2008. In essence, it calculates whether companies are likely to beat earnings in the future. Along with it is the sharp decreases in analysts estimates. As you can see, the ER has risen as expectations have fallen. This means that analysts are cutting their estimates too far too fast and companies are outperforming. As we saw last quarter, this bodes well for corporate earnings. Although last quarter was a disaster by any standard, the figures were “better than expected” and triggered the current market rally. I think we could be in for another quarter of the same treatment.
My preliminary glance at Q2 estimates and overall earnings leads me to believe that it will be a very bad idea to be short heading into this next earnings season unless estimates jump in the next 6 weeks. Alcoa doesn’t report until July 7th and earnings will pick-up momentum in the two weeks after. I still believe the market could run into some resistance between now and then, but as of now the earnings trends bode well for stocks. Of course, this isn’t necessarily a positive long-term trend as earnings will still be down sharply – it’s more a reflection of the short-term ignorance of the analyst community. Plus, most of the earnings outperformance is due to cost cutting as opposed to real organic growth. I’ll update this weekly as we get closer to the real thing.
*Thanks to HankB for the donation
Are you turning bullish?
Dont think he is turning bullish. Think he is giving a short term opinion of not being bearish. Anyways, the sentiment right now is to buy on the dips so I doubt any big correction will happen but definitely the market is looking a bit tired…could be consolidation for another move up though I hope not.
TPC: You’re saying here that it’s a ‘bad idea to be short’, and that ‘we may be in for another quarter’ of beating estimates, but I thought you were a small, recent short here? Not beating you up, just asking.
I am not bullish in the long-term. And yes, I do have a small S&P short that is roughly flat right now. Earnings aren’t for 6 weeks. As of now I doubt I would hold that position through earnings season. Might even consider going long into earnings. I’ll keep you posted.
Analysts “cutting their estimates too far too fast” and therefore that “companies are outperforming” can only be taken so far. At some point, the analysts’ estimates become suspect…even by the village idiot. If this were not so, the fix would be permanently in: ALWAYS estimate low or even negative earnings so firms can beat them and stocks can go up more…that is, there would never be overestimation.
The key JD, is earnings power. When corporations have earnings power the analysts are puddy in their hands. If you know you’re going to see 15% revenue growth next quarter you go out and tell the analysts you will see 10% earnings growth. Then you beat and raise guidance. Rinse wash repeat. What happens in a bear market is that companies lose earnings power and the analysts are a step behind them because companies generally stop giving detailed guidance during downturns. This is why my ER got so skewed and went negative in 2007. It only stabilized because companies began beating estimates again because their earnings power is coming back.
If we’re beginning to see some earnings stabilization we’ll begin to see more and more earnings beats. The analyst community in general is very poor at guessing future earnings. It’s important to note that this isn’t necessarily sign that a new bull market is ahead.
TPC,
I’m a first time visitor and a fellow Hoya MBA (94′). I suspect like a lot of other new unique visitors I followed Joe’s link from Clusterstock.
For the last fifteen years I’ve worked on the buyside managing institutional EM equity, EM debt and global private placement portfolios; in other words, I’ve seen the horror and had my fair share of meetings with sellside analysts, economists and strategists. I agree completely with your characterization of managements’ ability to manage sell side analysts’ expectations.
With respect to 2Q09 earnings I’m less willing to make a definitive call; there is less visibility today than at almost any other time in my career. Nonetheless while I’m uncertain about the 2Q09 I’m really less sanguine about 2H09; it seems on this point we agree.
Earnings matter and it’s unlikely that profitability will continue to be driven by squeezing COGS and SG&A or by deferring capital investment. In the last six months, on the private side, I’ve seen all three occurring and yet firms in a wide variety of sectors and in a wide variety of markets all over the world are still having difficulty meeting privately negotiated leverage and coverage covenants.
The financial risk profile of the US consumer has deteriorated significantly, lenders are less generous and, as a result, consumption as a percentage of GDP must revert toward the ~63% historical average.
Perhaps I’ve spent too much time managing fixed income and have become too risk averse; the glass is always half full. In this market trying to trade earnings expectations is too cute for me.
Inside,
Great to see you here. Hoyas are always welcome. I don’t disagree with anything you’ve said. My experience has always been that you fixed income guys are always a bit more rationale than the rest of the market.
With regards to 2Q earnings, my preliminary numbers are showing earnings that could be relatively easy to beat assuming the estimates stay where they are. That doesn’t mean the long-term outlook is good, however. I continue to see weak revenue trends and margin contraction across the board. The visibility is truly horrific as you said. In the near-term though, the expectations look beatable.
Nice comments. I hope to see you around here more often.