The year certainly got off to a hot start, with the S&P 500 adding almost 5% through Jan. 27, but a weak fourth-quarter earnings season suggests stocks might — just might — have gotten ahead of themselves.
The tepid economic recovery in the U.S., signs of recession in Europe and cyclically peak corporate profit margins led analysts to cut their forecasts heading into the reporting season, meaning companies should have had little trouble beating Wall Street estimates. And yet, in the aggregate, fourth-quarter reports have had a hard time exceeding even the most tempered expectations.
Of the 184 companies in the S&P 500 that have reported fourth-quarter earnings so far, just 59% have beaten Street expectations, according to data from Thomson Reuters. That’s the lowest “beat” rate in more than a decade, or since the fourth quarter of 2001.
Also troubling is that the fourth-quarter earnings growth rate for the S&P 500 stands at 7.9% so far — or pretty much in line with expectations — except that’s mostly thanks to Apple‘s (NASDAQ:AAPL) blowout report. Exclude Apple, the second-biggest company in the S&P 500 by market cap after Exxon Mobil (NYSE:XOM), and the market’s growth rate drops to just 4.7%, according to Thomson Reuters data.
Additionally, top-line growth continues to disappoint, with only 54% of companies beating Street revenue estimates. That’s the weakest revenue beat rate since the bull market began nearly three years ago. We’ve also seen more “split” reports, where companies exceed bottom-line results but fail to hit analysts’ average sales forecast.
“In addition to the lower than average percentage of companies beating earnings estimates, this earnings season has seen a significant number of companies beating earnings estimates, while missing on revenues,” Thomson Reuters analysts Jharonne Martis and Greg Harrison wrote in a note to clients.
Finally, and perhaps most disconcerting, is that guidance has been pretty lousy, too, notes Bespoke Investment Group. Recall that stocks are forward-looking (because they represent a claim on future earnings). Unfortunately, more companies are cutting forecasts than raising them for the second consecutive quarter. Indeed, the ratio of companies slashing vs. lifting outlooks this earnings season hasn’t been this bad since the fourth quarter of 2008.
“Citing global economic concerns, debt and credit worries, and other man-made and natural disasters, 101 companies in the S&P 500 have issued negative earning guidance compared to only 32 that have issued positive earnings guidance for the fourth quarter,” note the Thomson Reuters analysts.
If there’s a silver lining to the earnings season, it’s that the forward price-to-earnings ratio on the S&P 500 was already quite low heading into it. And even now, at just 12.5, the S&P 500’s forward P/E still is more than 25% below its historical average. That’s a blessing, because it means investors aren’t paying fat premiums for future earnings growth. A good part of companies’ poor profit guidance likely is already reflected in share prices.
Significantly, the market has shrugged off the poor earnings season so far, indicating traders are keying on something other than fundamentals. The most likely culprit is anticipation of a third round of quantitative easing from the Federal Reserve. Chairman Ben Bernanke appears to have paved the way for more stimulus last week — and Friday’s underwhelming GDP report only bolstered the case. If past is prologue, expectations that the Fed could run the printing press will shore up share prices no matter how disappointing the earnings season ultimately turns out.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
