Slashed profit ex­pec­ta­tions may set stage for gains

Claim­ing that the mar­kets ex­pe­ri­enced the worst in De­cem­ber and hav­ing al­ready priced the lower fourth quar­ter rev­enues ex­pec­ta­tions, strate­gists ex­pect brighter per­for­mance on stocks this year

Daily Sabah (Turkey) - - Money -

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 have 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 next week with re­sults from JPMor­gan Chase and other 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.

“Any 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 per­cent 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 per­cent since late Oc­to­ber and the stock had dropped more than 20 per­cent over the last year.

While still rel­a­tively strong at 14.5 per­cent, 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 per­cent, ac­cord­ing to IBES data from Refini­tiv. For 2019, an­a­lysts are ex­pect­ing profit growth of just 6.4 per­cent, down from an Oct. 1 es­ti­mate of 10.2 per­cent and a big drop from 2018’s tax cut-fu­eled gain of more than 20 per­cent.

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 in a re­port on Thurs­day.

The S&P 500 ral­lied 2.62 per­cent in that six-week re­port­ing pe­riod, and there have been just four prior earn­ings sea­sons since 2009 - when the U.S. 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 per­cent.

“An­a­lyst sen­ti­ment does not 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.

To be sure, the S&P 500 un­char­ac­ter­is­ti­cally de­clined 5.2 per­cent in the last earn­ings pe­riod de­spite neg­a­tive earn­ings re­vi­sions, ac­cord­ing to Be­spoke’s data.

That “proved to be a ma­jor ex­cep­tion” to the trend, they wrote.

Mar­ket val­u­a­tions also have come down sub­stan­tially. With the S&P 500 now trad­ing near 14.9 times ex­pected earn­ings, ac­cord­ing to Refini­tiv data, com­pared with a mul­ti­ple of 18 a year ago, mar­ket bulls ar­gue that stocks have be­come un­der­val­ued after the re­cent sharp de­clines.

In­vestors also will be lis­ten­ing closely to what ex­ec­u­tives say about de­mand in China.

Ap­ple cited slow­ing iPhone sales in China when it cut its sales fore­cast for the quar­ter that ended in De­cem­ber. Com­ments about China and its trade con­flict with the United States are likely to come up in con­fer­ence calls and could af­fect in­vestor sen­ti­ment, re­gard­less of the earn­ings num­bers.

“The com­men­tary we’re go­ing to get on China and trade is go­ing to be po­ten­tially pretty bad. It’s al­most like com­pa­nies re­serv­ing for things that could go wrong in fu­ture quar­ters,” said Jonathan Golub, chief U.S. in­vest­ment strate­gist at Credit Suisse.

Some strate­gists said what could make it a suc­cess­ful earn­ings sea­son from the mar­ket’s stand­point might sim­ply be any signs that 2019 earn­ings es­ti­mates are sta­bi­liz­ing.

“Just show­ing that these num­bers are not fall­ing off a cliff” will be pos­i­tive, said Keith Lerner, chief mar­ket strate­gist at SunTrust Ad­vi­sory Ser­vices in At­lanta. “That’s what the mar­ket was pric­ing in.”

Traders work on the floor of the New York Stock Ex­change (NYSE), Jan. 9, 2019.

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