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Market Back to the Future (Again)

Originally posted at Briefing.com.

The first quarter earnings reporting period is nearly complete with over 90% of the S&P 500 having reported results for the March quarter. What we have learned to this point is that the first quarter earnings decline was not as bad as expected. Still, the first quarter reporting period can't really be thought of as being good either.

According to S&P Capital IQ, aggregate S&P 500 earnings per share (EPS) are estimated to be down 6.0% year-over-year in the first quarter. When we published our earnings preview on April 8, it was thought first quarter EPS would be down 7.9%.

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Some other things learned coming out of the first quarter reporting period include the following:

  • There is still no revenue growth
  • Second quarter EPS is expected to be down from last year
  • Foreign exchange headwinds are lessening
  • Apple (AAPL) is no longer the growth company it used to be
  • Facebook (FB) and Amazon.com (AMZN) are absolutely dominating their industries
  • The automakers are doing well, only the market isn't necessarily buying the idea that they will continue to do well; and
  • Many mall-based retailers are getting killed by online/mobile shopping and a consumer spending preference for travel, electronics, dining out, home improvement, and autos

Forward Looking

Notwithstanding the better-than-expected results, the first quarter carries the ignominious distinction of being the third straight quarter that S&P 500 EPS has declined on a year-over-year basis. That hat trick hasn't been pulled off since the financial crisis; moreover, the 6.0% decline in first quarter EPS is the largest decline since the second quarter of 2009, according to S&P Capital IQ.

Those are some startling statistics, yet one is hard-pressed to say the market itself has been startled by them. Since April 8, the S&P 500 has increased 0.8%.

That's not a big gain, yet it qualifies nonetheless as a substantive move for a few reasons:

  1. It has come on the heels of a 13% gain for the S&P 500 between February 11 and April 8; and
  2. It reflects the market's forward-looking disposition

The second reason is the one that really resonates as the logical explanation for the stock market's resilience in the face of otherwise weak earnings.

No sector supports that forward-looking view more than the energy sector. It has registered the worst year-over-year earnings performance of any sector. Aggregate EPS for the sector declined by 106.6% in the first quarter since the sector actually reported a loss for the period.

Guess which sector, though, has been the best-performing sector since the start of the second quarter. Yep, it's the energy sector, which has increased 5.9% quarter-to-date.

The next best-performing sector has been the materials sector with a quarter-to-date gain of 2.8%. Incidentally, the materials sector registered an 11.4% year-over-year decline in first quarter EPS, which was the second-worst showing of all ten sectors.

In fact, only three sectors managed to report a year-over-year increase in EPS in the first quarter: the consumer discretionary sector (+20.0%), the telecommunication services sector (+9.1%), and the health care sector (+8.0%).

SectorQ1 EPS Growth (Yr/Yr)
Consumer Discretionary20.0%
Consumer Staples-0.4%
Health Care8.0%
Information Technology-5.8%
Telecommunication Services9.1%
S&P 500-6.0%

Source: S&P Capital IQ

Deja Vu

Things had a familiar look on the revenue side, too. First quarter revenue is estimated to decline 2.1%, which would be the fifth quarter in a row it has declined.

Again, the only three sectors reporting any revenue growth were the telecommunication services sector (+12.6%), the health care sector (+9.7%), and the consumer discretionary sector (+3.3%). The double-digit growth in the telecommunication services sector, though, was due primarily to AT&T's (T) acquisition of DirecTV.

The energy sector led all sectors with a 31.0% year-over-year decline in revenue.

SectorQ1 Revenue Growth (Yr/Yr)
Consumer Discretionary3.3%
Consumer Staples-1.0%
Health Care9.7%
Information Technology-1.8%
Telecommunication Services12.6%
S&P 500 -2.1%

Source: S&P Capital IQ

If the energy sector is excluded, first quarter EPS would be down 1.4%, according to S&P Capital IQ, while first quarter revenue growth would be up 1.3%, according to FactSet.

You can play that exclusion game if you so choose. We don't. Ultimately, it all counts in the valuation of the S&P 500.

As discussed in past columns, that valuation is a full valuation at best. That rings true whether you are looking at GAAP earnings or non-GAAP earnings and whether you are looking at things on a trailing twelve-month basis or a forward 12-month basis.

Still, the market has acted as if it is willing to discount that full valuation on the basis of economic and EPS growth accelerating in the back half of the year. That view has been predicated largely on the weakening dollar, the surge in commodity prices, easier comparisons, the pickup in job growth, and the persistence of ultra-low interest rates.

It's a logical position, but then again, so too was the belief in late 2014 that the collapse in oil and gas prices would be a huge boon for consumer spending. That hasn't happened and now both oil and gas prices are moving up again.

We digress. The simple point is that market logic doesn't always prevail—or perhaps it does, just on an extended timeframe. Hence, this market's battle cry for the last several years—and the battle cry of central bankers the world over—has been something on the order of, "just wait, you'll see the next six months is going to be much improved."

The problem over the last several years is that "the next six months" generally speaking has often looked a lot like the previous six months in terms of economic growth.

That's why there hasn't been much if any, revenue growth, and it is why companies have had to continue to rely on cost-cutting and/or share repurchases to deliver so often on lowered EPS growth estimates.

What It All Means

One of the thoughts entering the first quarter reporting period was that corporate guidance should start to improve. It did somewhat with a number of multinational companies, like Pfizer (PFE), DuPont (DD), and Amazon.com (AMZN), pointing to less onerous foreign exchange headwinds in the near future. Still, it would be remiss not to add that analysts' average EPS growth estimates for the second quarter, the third quarter, the fourth quarter, and calendar year 2016 are all lower today for the S&P 500 than they were on April 1.

PeriodEPS Growth Estimate (April 1)Current
Q2 2016-2.5%-5.1%
Q3 20164.8%2.5%
Q4 20169.4%8.3%
CY 20161.1%-0.05%

Source: S&P Capital IQ

The estimate trend is noteworthy on two fronts.

First, it's a trend that continues to underpin our low return expectations for 2016.

Secondly, it is a trend that paves the way for "better than expected" earnings in those periods just like we saw in the first quarter, six months before that, and six months before that when economic and earnings growth was weak and it was thought things would look much improved six months ahead.

Well, the future is now (again), and regrettably it still looks a lot like the past (again).

About the Author

Chief Market Analyst