Earnings Analogy of the Day
You are out at a family function and forced to miss the big game, so you record the game and will watch it well after the game has been decided. You spend the next few hours trying not to get updates of heaven forbid, learn of the final score. Ultimately, the charade lasts for much of the afternoon, but you are inadvertently told of the final score – blowing your enjoyment of the game as you now know the final score. The analogy being drawn today is that of earnings season. The game being played is the number of “beats” or how many companies are able to beat estimates providing investors a reason to buy the stock under the impression that things are getting better. However, the “game” has already been rigged in many cases as companies talk down guidance throughout the quarter to a point they know can be beat at quarter end. Just look at the percentage of companies beating estimates (from Bloomberg)
There was, at the worst part of the economic decline, a much better than usual chance of beating estimates. But note that only twice over the past six years did less than 60% of companies beat estimates. While not the 100% guarantee of knowing the outcome of a game before watching it, it is well ahead of the random coin flip – implying that analysts are really that good or estimates are set up to be beat.
Investors are trying to make the connection between earnings (better than expected) and the economy and implications for monetary and tax policy. Here is where the TV screen showing the game goes blank due to technical difficulties. Let’s start with earnings, which should rise to somewhere in the $90 per share range on the SP500, surpassing the prior peak achieved in the second quarter of 2007. Earnings growth is estimated to be up over 10% vs. the same period a year ago – not bad in a recessionary economy. What recessionary environment? Looking at housing, consumer spending, industrial production and employment one would guess that the economy is fairly weak as many of these indicators are up from the lows, but when compared to prior recessionary periods are still very close to those levels. Let’s check in with Fed Chairman Ben Bernanke for his take on the economy. According to the press release after their March meeting, the Fed decided in order to promote “a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities” and “will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” Unfortunately, that doesn’t necessarily sound nearly as rosy as what investors are seeing/hearing from companies regarding earnings.
Finally, with the wrangling in Washington, how are they viewing the economy? Based solely upon the rhetoric, it would seem that here too the economy can’t be too strong; as the Democratic concerns are that reducing the spending would hurt the economy and potentially push us back into a recession. While the Republican side is not really interested in raising tax rates, as it could hurt the entrepreneur that is so important to keeping the economy humming. Obviously for their own political agendas, both parties are not willing to admit that the economy probably doing better than they are giving it credit for at this time.
So here is the scorecard so far – corporations are doing well, just look at how the earnings are growing. The economy (at least domestic) is fair to middling as large chunks of the economic engine are still sputtering. Finally, the monetary and elected officials don’t think the economy is all that strong either. All this begs the question – how long can corporations pull off earnings growth without economic and consumer strength?
About Paul J Nolte CFA
Paul J Nolte CFA Archive
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