Lower profits may mean gains
new york — There could well be a silver lining in all the caution around the stock market as the earnings season approaches: shares do way better when profit expectations have fallen, and lately, they’ve been falling like a rock.
By at least one measure, this is the most negative analysts have been ahead of a reporting period in nearly four years. Fourth-quarter reports get rolling this week with results from big banks.
Recent warnings on the quarter from high-profile companies have had investors bracing for more bad news. Earlier this month, Apple’s big cut in its revenue forecast added to fears among some market watchers that a possible 2019 earnings recession — defined as at least two straight quarters of profit declines — may be on the horizon.
With the bar low for companies to beat expectations, stocks could extend recent gains following the S&P 500’s worst December performance since the Great Depression.
“One of the key things the December selloff did was it priced a materially reduced set of earnings expectations for 2019. As a result, investors are going to be somewhat forgiving of companies who either miss estimates or are somewhat tentative in their guidance because they are now expecting that,” said Lisa Shalett, head of investment and portfolio strategies at Morgan Stanley Wealth Management in New York. “Companies that talk about 2019 being just as good as 2018 or even sequentially a lot better are going to constitute an upside surprise,” she said.
Case in point: General Motors. GM’s shares soared more than 9 per cent on Friday after the company said its earnings would top its earlier forecast.
Coming into that surprise announcement, Wall Street’s estimates for GM’s fourth-quarter profit had fallen by 12 per cent since late October and the stock had dropped more than 20 per cent over the last year. While still relatively strong at 14.5 per cent, analysts’ estimated profit growth for S&P 500 companies in the fourth quarter has fallen sharply since the start of October, when they forecast growth of 20.1 per cent, according to IBES data from Refinitiv.
For 2019, analysts are expecting profit growth of just 6.4 per cent, down from an October 1 estimate of 10.2 per cent and a big drop from 2018’s tax cut-fuelled gain of more than 20 per cent. According to strategists at Bespoke Investment Group, the bar for this earnings season is “extremely low”.
Heading into the fourth quarter, Bespoke analysts’ earnings revisions for S&P 1500 companies are skewing more negatively ahead of any reporting period since the first quarter of 2015, they wrote.
The S&P 500 rallied 2.62 per cent in that six-week reporting period, and there have been just four prior earnings seasons since 2009 — when the US bull market began — in which the earnings revisions spread for the S&P 1500 was more negative than it is now, they said.
In each of those periods, the S&P 500 rose for an average gain of 4.33 per cent.
“Analyst sentiment doesn’t get much more negative than it is now, so if we start to see companies react positively to results early on, it would set the stage for a positive earnings season,” the Bespoke strategists wrote. —
Investors are going to be somewhat forgiving of companies who either miss estimates or are somewhat tentative in their guidance because they now expect that
Lisa Shalett, Head of investment and portfolio strategies
at Morgan Stanley Wealth Management