Originally posted at Briefing.com
First quarter earnings results aren't expected to be very good. According to data compiled by S&P Capital IQ, S&P 500 earnings per share are currently projected to be down 3.2% versus the same period a year ago. There hasn't been a year-over-year decline in the quarterly growth rate since the third quarter of 2009.
What is assumed ahead of a reporting period though isn't often what is understood at the end of a reporting period.
The final S&P 500 earnings per share (EPS) growth rate typically ends up being two to three percentage points higher than what is expected at the start of a reporting period. A case in point was the fourth quarter of 2014. The final EPS growth rate for that period was 7.8% versus a 4.6% growth rate projected on January 9.
With the historical trend in mind, the first quarter earnings results will likely end up better than feared. That isn't the same though as saying they will end up being good.
Two Is Company, Five Is a Crowd
Everyone presumably knows by now that the main source of earnings weakness is the energy sector, where earnings estimates have followed oil prices sharply lower.
According to S&P Capital IQ, the latest consensus estimate for the troubled sector has first quarter EPS declining 63.8% versus last year. There won't be anything pretty about energy sector earnings even if they end up "better than expected."
If the energy sector is excluded (which is an exercise in see no evil, hear no evil, and speak no evil thinking), EPS growth for the remaining portion of the S&P 500 would be approximately 6.0%.
Such exclusions don't — and shouldn't — apply because it all matters when it comes to valuing the market.
An important item not to be forgotten in considering the first quarter earnings reporting period is that it isn't just the energy sector that is expected to see EPS decline on a year-over-year basis. As seen in the table below, the materials, utilities, telecom services, and consumer staples sectors are also expected to report a year-over-year decline in earnings per share.
Source: S&P Capital IQ
We are informed by S&P Capital IQ that this is the first time since 2009 that five sectors are anticipated to report a decline in earnings for a given period.
That's a remarkable point when one stops to consider where the world is today versus where it was in 2009 and knowing, too, that the telecom services sector is the only one that is up against a truly tough comparison (+27.4%).
Constant Currency Is the New Black
The first quarter presented some difficulties for U.S. companies. The winter weather was unusually harsh in many parts of the country, but particularly in the heavily-populated northeast region. The West Coast port slowdown caused inventory management headaches for a host of companies. And of course the dollar continued to strengthen, serving as a headwind for U.S. exporters and companies generating non-dollar revenue in foreign countries.
The latter is expected to lead to a pickup in sales/earnings warnings for companies doing business abroad. We suspect, though, it will also lead to an increased emphasis on results measured on a constant currency basis (i.e. eliminates exchange rate fluctuations).
Multinational companies have long reported constant currency results in conjunction with results that include the impact of exchange rate volatility, yet they have rarely done so at a time when the dollar has traded like a growth stock.
The U.S. Dollar Index is up 10% year-to-date versus a 2.0% gain for the S&P 500. The former is a huge move in currency market terms and it has followed on the back of considerable depreciation of the euro.
Because of the extraordinary nature of the dollar's move, which was very unlikely to be captured by companies that use hedging programs and hits directly at multinational companies that don't, we expect it will become fashionable in earnings press releases and on earnings conference calls to highlight results measured in constant currency.
In other words, constant currency reporting is apt to be the new black in the first quarter reporting period.
What It All Means
What we find interesting leading up to the full rush of earnings reporting is that the market is still trading within a stone's throw of its all-time high. That's remarkable given the downward earnings revisions since the fourth quarter reporting period and the persistent slate of disappointing economic data that was seen throughout the first quarter.
The resilience is likely rooted in the following factors:
- the persistence of the fed funds rate at the zero bound, which is forcing the asset allocation hand of active money managers seeking yield
- an appreciation for the point highlighted above that final earnings results almost always end up better than expected; and
- the expectation that economic and earnings prospects will improve as the year progresses with the flow through of rising employment levels, low gas prices, more stable oil prices, and an abatement of the dollar's strength
Accordingly, this market seems geared to write off disappointing first quarter earnings in favor of its longstanding mentality that the next six months are bound to be better. It goes to show how interest rates at the zero bound are able to buy a lot of time to think happy thoughts.
One thing that is known for certain is that this market expects to hear a lot of negatives with respect to the first quarter reporting.
Its ability to glide past those negatives will revolve around the tenor of the aggregate guidance and whether it truly clouds the market's rose-colored thinking. Thus far, there hasn't been anything that has had lasting success in that respect for it has been hard to unseat interest rates at the zero bound as the market's main driver.
Patrick J. O'Hare, Briefing.com
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Charles Biderman: Earnings Are Irrelevant - Companies Driving Market Higher With Record Buybacks
