Saturday, April 2, 2016

Four things you better worry about this earnings season

S&P 500 companies are expected to post lower earnings for the fourth straight quarter

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Be afraid. Be very afraid this earnings season.

If you thought the fourth-quarter earnings season that just ended was miserable, brace yourself: the next one will be a real doozy.
S&P 500 companies are expected to post their fourth straight quarter of earnings declines and fifth straight quarter of sales declines, according to FactSet. The last time earnings fell for such a long stretch was the period between the fourth quarter of 2008 and the third quarter of 2009, right after the financial crisis.
And stop blaming energy. This time, the pain is more evenly spread across sectors.
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“While much of the softness is attributable to the energy sector, it is worth noting only three of the S&P’s 10 macro sectors are expected to show an increase in earnings,” said Jeffrey Saut, chief investment strategist at Wells Fargo. “ Those are consumer discretionary, telecoms and health care.”
The season unofficially kicks off on April 11, when aluminum giant Alcoa Inc. AA, +0.52%  reports after the bell.

S&P 500 companies are expected to show an overall earnings decline of 8.5%, and a sales decline of 1.1% for the quarter, compared to the same quarter a year earlier, according to FactSet.
At least Wall Street may be prepared. Analysts kept busy revising estimates downward through the first quarter, which they did at the fastest pace since the first quarter of 2009.
“The Q1 bottom-up EPS estimate (which is an aggregation of the estimates for all the companies in the index) dropped by 9.6% (to $26.32 from $29.13) during this period,” said FactSet senior research analyst John Butters. That compared with an average 4.4% in the last year, 4.0% in the last five years and 5.3% in the last 10 years.
Contrarian view: Profits don’t matter as much as you think to stock-market returns
All 10 of the S&P 500’s subsectors are showing lower growth rates today than they were at year-end, with the energy sector leading the revisions.
Here are four things to know about this earnings season:
There will be no growth
As MarketWatch’s Wallace Witkowski explained on Thursday, nearly a fifth of S&P 500 companies are expecting to miss estimates, the second-highest number since FactSet started to track that data in 2006. In fact, it is difficult to imagine that many companies achieved any growth at all, given the continued pressure on revenue and mixed macro environment.
Add to that the fact that companies have spent billions of dollars on stock buybacks and dividend hikes in the last few years, using up funds that could otherwise have been spent on measures to stimulate growth. The buyback machine will likely be throttled back, according to HSBC, as rising interest rates have made it more expensive to borrow for shareholder returns, and negative interest rates around the world are subduing sentiment. HSBC made the case that the end of buybacks will be bad for stocks, as it removes a major buyer of U.S. equities.
See also: Share buyback machine remains in overdrive and experts warn it will end badly
The futures and options trader known as Northman Trader argues that the 15% decline in GAAP earnings of the past year has made the market expensive on a GAAP price/earnings basis. At the same time, 78% of companies issued earnings warnings in the first quarter, and that doesn’t include energy companies, which have more or less thrown in the towel on forecasting.
“GDP has come in much lower than expected as well, with the Atlanta Fed taking it down from 2.5% to 0.6% in just a few weeks,” he wrote. “So my principal take is unless these GAAP earnings start to improve this recent rally is not sustainable.”
Analysts at research firm Paviliion said for sales to rise would require sizable depreciation or a large, organic acceleration in demand leading to stronger sales. “We’re not sure that we see either in the near term,” they wrote in a note.
Low oil prices are still mostly a pain point
The theme of low oil prices will again feature prominently this earnings season, even after futures staged a strong rebound off their Feb. 11 low of $26.21 a barrel.
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The low oil price has taken a huge toll on energy companies, especially the many shale plays that had emerged during the fracking revolution. Energy consulting firm Rystad Energy estimates that many of these companies need an oil price of $60 a barrel to remain profitable. The price has also been a problem for banks that lend to the sector. Bank loan loss provisions are expected to rise 8% to 10% in the medium term, according to a Macquarie note published Friday.
“The environment for banks continues to be challenging, and we are taking a more cautious view regarding near term earnings power by incorporating expectations for higher energy-related loan provisions coupled with a lower assumption for the near term interest rate outlook,” Macquarie analysts wrote.
Meanwhile, the beneficiaries of low oil prices are also showing cracks. The consumer, who is expected to benefit from lower gas prices, took a wobble in March, as measured by consumer confidence. The University of Michigan’s consumer sentiment survey fell to a reading of 91 from 91.7 in February, marking the fourth monthly fall in a row.
Airlines, which have lower fuel costs when oil is cheap, are grappling with another headwind, according to Deutsche Bank. analysts.
“We have observed a slowdown in U.S. corporate profits which is a concern given that they are a leading indicator of economic activity, and therefore, could lead to reduced demand for corporate travel,” they wrote in a note Friday, downgraded American Airlines Group Inc. AAL, -3.63% Delta Air Lines Inc. DAL, -3.43% United Continental Holdings Inc. UAL, -5.25% and Hawaiian Holdings HA, -2.48% to hold from buy.
The greenback is a headwind
The dollar, a major whipping boy in the last several quarters, will no doubt feature strongly in earnings this season, even after it logged its worst quarterly performance since the third quarter of 2010. The ICE U.S. dollar index DXY, -0.02%  fell 4.2% in the quarter, while the euro gained 4.8%. For companies, the weakening of the U.S. currency is unlikely to have significantly helped improve first-quarter earnings, although it will be interesting to see if there are fewer disclosures that attempt to strip out its effect. Dollar strength has been described as a major headwind by companies across the board in the past year.
The China syndrome
China will no doubt show up in many earnings reports, as companies update investors on how their business is performing there. China has transformed from being mostly a source of cheap goods and semifinished products for U.S. companies to a promising market with a burgeoning middle class that is now embracing consumer goods.
China’s slowdown is one of the reasons for the global commodities rout of the last year, as it is a major consumer of oil and metals. It is widely held to be the economy Federal Reserve Chairwoman Janet Yellen was referring to in comments this week to The Economic Club of New York that the Fed was taking a more cautious approach to rate hikes because of worry about global growth crimping U.S. growth.
A slew of recent data that fell short of expectations has some economics forecasting that first-quarter growth will fall to the bottom of the government’s target of 6.5% to 7.0% growth for 2016.
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