Friday, July 2, 2010

Earnings Season Unlikely to Provide Clarity


Companies may not be able to provide much guidance. But lowered expectations may be easy to beat.

IF BRUISED AND BEWILDERED INVESTORS expect the outlook for stocks and the economy to be clarified by second-quarter corporate earnings reports, they are apt to be disappointed.
"Second-quarter earnings aren't going to tell us anything about whether we're going to have a double dip or not," says James Dailey, senior portfolio manager of the TEAM Asset Strategy Fund.

If anything, strategists and analysts have been cutting back their forecasts in recent weeks, not coincidentally since stock prices peaked in late April. Yet that might provide a low bar for companies to beat forecasts and provide support for sagging stocks.

Even the forward-looking commentary and guidance from management teams that investors will be hanging on to may not help much. It might be too early for management teams to offer much in the way of credible information, according to Tobias Levkovich, chief U.S. equity strategist, for Citigroup Global Markets.

Uncertainties regarding Europe's austerity programs, new economic data, the composition of Congress and expiring tax cuts in the U.S. make attempts at guidance little more than a guessing game, he says.
"In my mind the question is, will we get answers from those conference calls or press releases from management teams about the future?" says Levkovich. "Will they be able to give us great perspective into 2011? And I think the answer is no. These are reasons I have difficultly believing that we walk out of the July quarterly earnings period with a strong sense of confidence," he contends.

The reports are set to begin in earnest on July 12, when Alcoa (ticker: AA) delivers its quarterly results.
To be sure, corporate profits are estimated to have increased again in the quarter just ended. Analysts forecast profits of the Standard & Poor's 500 companies to increase by an aggregate 27% from a year earlier. That performance would represent the third consecutive quarter of year-on-year earnings growth for the index, following two years of quarterly declines.

Materials, energy and information-technology sectors are expected to have driven much of the second-quarter growth, while utilities and telecom services are seen posting the only profit decline among S&P sectors, according to Thomson Reuters.

At Standard & Poor's, the strategy team sees corporate profits boosted by higher volume and prices, which would more than offset weakness tied to Europe and the U.S. housing market.

Expectations for calendar 2010 corporate growth are even stronger, based on the Thomson Reuters consensus, with a forecasted 33.6% improvement in S&P earnings to $81.99 a share.

But there are signs that the earnings momentum is losing steam.
In June, just 46.7% of all earnings revisions were in an upward direction, according to Citigroup, well below a peak May ratio of 72%, and under the 48.6% average since 1990.

Economic bellwether FedEx (FDX), for one, recently disappointed the market by predicting that earnings would be constrained in 2011. (See Stocks to Watch Today.)

Not surprisingly, the shift in revisions has correlated with the market's correction. The S&P 500 is down 16% since topping out at 1219.80 on April 26.

Looking at the broader S&P 1500—which consists of the large-cap S&P 500, the mid-cap S&P 400 and the small-cap S&P 600—as a benchmark, analyst sentiment is more negative than at any time since May 2009, according to Bespoke Investment Group. The research firm notes that in the last four weeks, negative earnings revisions have outpaced positive ones by 545 to 373.

Based on the consensus estimates for the next 12 months, the S&P 500 looks cheap by historical standards at a price-earnings ratio of just 12.1 times. That compares to an average of 14.4 for the last 12 months and 14.2 in the last five years, according to Thomson Reuters.

"Let's face it, the bull market over the past year has been all about earnings," says Ed Yardeni, president and chief investment strategist of Yardeni Research. "All the concerns that investors have had over the last year have been trumped by earnings surprises. But investors now are turning to more macro issues than they are to specific earnings."

Nevertheless, diminished expectations could ultimately provide some support for stocks in the near term.
"If there is any bright side to the fact that analyst sentiment has shifted so fast to the negative side, it is that the expectations bar is likely to be very low by the time earnings season kicks off in early July," Bespoke wrote in a recent note to clients.

Strategas Research Partners strategist Nick Bohnsack thinks estimates still have further to fall for 2011, with the consensus expecting an all-time record of $96.34 per share. He sees S&P 2011 earnings at $86.75 per share, but thinks multiples will move "softly higher" as analysts reduce their estimates. Using his estimate, and a historical multiple of 14 times, gets the S&P 500 back to 1215, in line with its April high.

The bottom line is management teams have a tough task ahead in grabbing investors' attention.

Earnings have been relegated to the sidelines, as investors "focused on the Hellenic debt crisis, Chinese growth, the Korean peninsula, Israeli flotillas, oil spills, hurricanes and earthquakes," Bohnsack says.

"I do think some corporate news could get folks to lay off stocks' case for a little while."
And that might be the best thing to come out of the coming earnings season.

Corporate Profits Still Growing

The upcoming earnings season is expected to produce positive profit growth, for the third straight quarter.
Sector Earnings Growth Estimates

2Q10 2010 2011
S&P 500 Average 27%34%17%
Consumer Discretionary 48%36%17%
Consumer Staples 6%6%10%
Energy 71%48%24%
Financials 21%147%33%
Health Care 5%7%9%
Industrials 15%19%20%
Materials 94%80%25%
Technology 55%37%11%
Telecom -2%3%12%
Utilties -6%1%4%

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