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Earnings Season Will Be Ugly, But Prettier Than Expected

Profits won't be good, but they'll beat expectations


First-quarter earnings reporting season unofficially kicks off Tuesday when aluminum giant Alcoa (AA) release results, and if analysts’ forecasts are correct, this is going to be the best bad earnings season we’ve had in some time.

Profit Losses EarningsRemember that Wall Street doesn’t care about results in a vacuum. It cares about results vs. expectations. And thanks to that long spell of bitter winter weather and genuine signs that the economy has stalled, Street expectations are even lower than usual.

That should set up plenty of opportunities for earnings reports to beat estimates — and trade higher — even as the broader market suffers a year-over-year drop in profits.

Sure, this has been playing out for years. Expectations have been so low heading into past earnings seasons that companies can trip over them, but this season is really loaded with pessimism. Indeed, the number of companies issuing profit warnings for this quarterly earnings season is at a near-record, according to FactSet. The number of companies raising their guidance ahead of earnings is likewise near a record low.

And this could all set up to surprise on what look like bad earnings. Even if the season turns into a tale of weather wipe-outs, the market could still gain on earnings news because it’s braced for so much worse.

Savita Subramanian, head of U.S. Equity Strategy & U.S. Quantitative Strategy at Bank of America Merrill Lynch, writes in a report:

“As we have seen every quarter over the last several years, analysts have slashed their initially-too-optimistic forecasts ahead of earnings season. But estimates have come down more dramatically than usual for 1Q due to weather, concurrent with increasingly negative management guidance.”

Just look at what all the “better-than-expected” early earnings reports have served up so far. Some companies report earnings ahead of everyone else, and these early reporters are having no trouble beating the Street. Subramanian writes that 52% of the 21 early reporters have exceeded on both earnings and sales — “higher than last quarter’s 42% hit rate, and the best result from the early reporters since 1Q12.”

That doesn’t mean the results were good, mind you — just that they beat Wall Street estimates, which is what earnings season is all about.

How else do we explain the fact that stocks are hitting all-time highs even as S&P 500 earnings are forecast to fall 1.2% for the first quarter? That would be the first drop since the third quarter of 2012, according to data from FactSet.

It’s because S&P 500 earnings won’t fall 1.2% Enough companies will beat expectations by a wide enough margin to pull year-over-year profit growth into the black.

What’s really at stake this earnings season is sorting out how much of the pain comes from bad weather and how much stems from a stalled recovery. Even the biggest beat in the history of earnings season won’t help the market if suspicions are aroused that the economy is sputtering out.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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