An­a­lysts cast a skep­ti­cal eye on quar­terly earn­ings sea­son


With quar­terly earn­ings sea­son set to be­gin in earnest, the out­look for cor­po­rate profit growth has sud­denly weak­ened.

Amid signs that the global econ­omy could slip into a syn­chro­nized slow­down, earn­ings es­ti­mates for 2018’s fourth quar­ter and for 2019 have been re­vised down sharply in re­cent weeks, rais­ing doubts over one of the mar­ket’s key sources of strength.

Sev­eral large U.S. banks will re­lease their fourth-quar­ter earn­ings this week, and mar­kets will be look­ing for growth sig­nals in fi­nan­cial re­sults and in man­age­ment com­ments about the year ahead.

“This earn­ings sea­son is go­ing to be re­ally im­por­tant,” said Ja­son Mann, chief in­vest­ment of­fi­cer of Toronto-based Edge­hill Part­ners. “Is this trade war re­ally start­ing to bite, are we see­ing any weak­ness in the con­sumer, are com­pa­nies talk­ing about lay­ing peo­ple off?”

Those ques­tions took on some ur­gency after U.S. stocks suf­fered through their worst month of De­cem­ber in nearly 90 years, crush­ing in­vestor sen­ti­ment around the world.

As the main U.S. stock in­dexes piled up losses, drop­ping close to 20 per cent from their Septem­ber peaks up to Christ­mas Eve, an­a­lysts were also cut­ting their earn­ings fore­casts.

For com­pa­nies in the Stan­dard and Poor’s 500 in­dex, to­tal fourth-quar­ter earn­ings growth is now ex­pected to be 14.5 per cent, ac­cord­ing to data pro­vided by Refini­tiv. While that’s still rel­a­tively high, it’s down from an es­ti­mate of 20.1 per cent just three months ago – part of an earn­ings surge fu­eled by U.S. cor­po­rate tax cuts.

Cor­po­rate Canada has been hit with a sim­i­lar down­grade, with S&P/TSX Com­pos­ite In­dex earn­ings growth ex­pected to come in at 4.3 per cent for the fourth quar­ter. At the start of Oc­to­ber, that es­ti­mate sat at 12.9 per cent.

The sil­ver lin­ing to such a dra­matic re­duc­tion in profit ex­pec­ta­tions is that it makes for a much lower hur­dle for com­pa­nies to clear.

Beat­ing the con­sen­sus es­ti­mate is of­ten hand­somely re­warded by the mar­ket, though last earn­ings sea­son seemed to buck that tra­di­tion.

With sen­ti­ment soft­en­ing in early Oc­to­ber, and with eq­uity val­u­a­tions high rel­a­tive to his­tory, in­vestors soundly pun­ished the stocks of com­pa­nies that missed third-quar­ter earn­ings pro­jec­tions, while largely ig­nor­ing those that beat fore­casts..

“In Canada, ev­ery com­pany that missed even by a lit­tle bit just got killed,” Mr. Mann said. “I think this quar­ter, it’s go­ing to be the op­po­site.”

This time around, the mar­ket has more of a valu­a­tion cush­ion. Over the last three months, the price-to-earn­ings ra­tio on U.S. large-cap stocks has de­clined by more than 15 per cent.

As for Cana­dian stocks, in­vestor sen­ti­ment is so low rel­a­tive to his­tory that they are ar­guably less sus­cep­ti­ble to neg­a­tive earn­ings re­ports.

“Re­source stocks are com­pletely bombed out,” said Martin Roberge, a port­fo­lio strate­gist at Canac­cord Ge­nu­ity. An in­dex that tracks TSX-listed ma­te­ri­als stocks lost nearly 9.3 per cent last year; one that tracks Cana­dian en­ergy shares lost more than 26 per cent.

De­spite the very real pos­si­bil­ity of fur­ther down­ward re­vi­sions to Cana­dian earn­ings, “cheap val­u­a­tions on re­source and non-re­source cycli­cals over­rides TSX [earn­ings] risk,” Mr. Roberge wrote in a note.

Be­yond the fourth quar­ter, the cor­po­rate sec­tor’s out­look for the year ahead will be closely watched for signs of growth vul­ner­a­bil­ity.

Ap­ple Inc. set a dis­cour­ag­ing prece­dent on that front ear­lier this month, when it cut its rev­enue fore­cast for the first time in nearly 20 years, cit­ing weak de­mand in China. That stoked fears of a broad slow­down in the Chi­nese econ­omy.

For the en­tire S&P 500, earn­ings for 2019 are ex­pected to grow by 6.4 per cent, which is down from 10.2 at the start of the fourth quar­ter.

“I think that many an­a­lysts are still too bullish in their out­looks for 2019,” said John Zech­ner, pres­i­dent of Toronto-based wealth man­age­ment com­pany J. Zech­ner As­so­ciates. “I ex­pect the news to re­main bleak on earn­ings and the econ­omy in the year ahead and that will be the tougher test for stocks in 2019.”

The other pos­si­bil­ity is that the re­cent soft­en­ing of cor­po­rate prof­its and eco­nomic ac­tiv­ity rep­re­sents a pull­back to a slower pace of growth, rather than an out­right con­trac­tion. In that case, it’s plau­si­ble that the mar­ket has al­ready cor­rected enough.

“I don’t think we’re go­ing to see a broad-based de­te­ri­o­ra­tion in earn­ings,” said Ed Perks, chief in­vest­ment of­fi­cer of the mul­ti­as­set so­lu­tions group at Franklin Tem­ple­ton In­vest­ments, cit­ing the strength of the U.S. con­sumer as a con­tin­u­ing driver of eco­nomic growth.

“Hear­ing banks talk about the con­sumer ap­petite for loans is go­ing to be an im­por­tant start­ing point,” he said.

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