Monday, February 15, 2016

When Will The Earnings Recession End?

As I have explained in a couple of blog posts (here and here, etc.), we are in an earnings recession. That is, S&P 500 earnings are getting worse. This is different from an economic recession. In fact, there is plenty of evidence that the economy is improving, despite what political scare-meisters want you to believe.

How can earnings get worse if the economy is improving? It's a devil's trifecta of a too-strong dollar, low oil prices that hammer energy sector earnings (also bank earnings, because they're ones holding loans for the energy companies) and global economic growth that is too slow to sustain previously optimistic earnings expectations.

After all, if you're an S&P 500 company that sells all over the world, and Europe is teetering on the brink of recession, that's really going to hurt your earnings potential. Doubly so if you are manufacturing in US dollar terms and trying to make a profit in euro terms. Until recently, that was a bad trade.

The good news is that, thanks to external forces, the Fed's threat to keep raising interest rates (which supported a strong dollar) seems as empty as a bag of campaign promises.

So, let's take a look at the latest earnings projections for both Q4 2015 and Q1 2016.

Q4 2015 ... Down, but Not as Bad as Was Feared

According to data from ValueWalk, I would describe earnings for Q4 as "bad, but improving." Aggregate fourth quarter estimates  stand at $29.06 as of Friday. That is a 4.9% year over year decline. A week earlier, the estimate stood at $28.99, representing a 5.11% decline year over year,

By sector, telecommunications is leading the way higher, while Energy is the biggest laggard. If you're surprised energy is a laggard, my recommendation is you sell all your stocks and go buy an index fund.


Q1 2016 ... Getting Worse

Earnings estimates for Q1 continue to get worse. Most recently the estimate for the broad S&P 500 is a 5.06% decline year over year.

Here's the thing. On Thursday, the S&P 500 has a forward 12-month P/E ratio of 15.2x. That was the lowest in two years and down 13% from 17.4x at the start of 2016, according to Bloomberg data.


Bloomberg estimates that full-year S&P earnings will rise 4%. That's not in line with ValueWalk's numbers.

Well, the lowest forward P/E ratio in two years sounds like a bottom, right? No wonder everybody bought the market on Friday.

Still, the S&P 500 probably hasn't fallen far enough to reflect the rapidly lowering Q1 earnings numbers. And there's another thing. Bloomberg takes an awfully short-term view of the market. Maybe that's how traders think. But let's take a little longer-term view, by revisiting a chart I've shown you a couple times.

You can see that at Friday's close, the S&P 500 had a forward P/E of 15.5. That is just slightly below average. That is no where near support. And if earnings estimates are getting worse, I would expect the S&P 500 to fall further. 

Individual sectors will outperform, and individual stocks, certainly. This has become a stock-pickers market.

By the way, ValueWalk expects earnings will fall, year over year, in Q3. But by Q4, their consensus is that earnings will start to grow again.

So that's the good news. When will the market start pricing that in? My crystal ball is cloudy.

And everyone disagrees on earnings estimate. Zacks, which seems particularly bearish to me, has earnings estimates HERE. They also cover the Russell 2000, which is interesting.

The latest Thomson Reuters earnings dashboard I can find is from February 9th. You can look at that HERE.  At the time, T/R was calling for a 4.1% decline in S&P 500 Q4 earnings. That's slightly better than ValueWalk. The T/R outlook for Q1 is a 4.2% decline in earnings.

By the way, Business Insider has a bearish view on the earnings recession, with some nice charts. You can read that HERE.

One bright ray of hope for the bulls: Investor Sentiment is quite bearish. Usually, that is followed by positive gains in stocks 3- and 6-months down the road.

I hope this helps. Good luck and good trades.

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