Everyone’s calling for grim Q1 earnings. Here’s what to expect, and how to prepare yourself
Based on many financial headlines, we’re standing on the edge of an earnings season that’s going to thrust us into an “earnings recession” that almost sounds apocalyptic.
Q1 earnings season begins in earnest next week when we hear from JPMorgan and Wells Fargo. For the S&P as a whole, analysts are predicting a year-over-year earnings decline of 3.9%. That would make it the first negative earnings quarter since 2016. That number appears especially painful given that the S&P enjoyed 25% earnings growth on a year-over-year basis this time last year.
Fortunately, despite the various fearmongering headlines, the sky is not falling. Yes, things could get bumpy, but it’s important to view this upcoming earnings season in context. So, in this Digest, let’s talk about what to expect.
***First, if you’ve been following Louis Navellier, you’ve been anticipating an earnings slowdown for a long time
Louis Navellier is one of the most widely-respected growth investors in the industry. In Growth Investor, he analyzes fundamentals and earnings growth to identify the companies best positioned to produce superior returns going forward.
Louis has been preparing his subscribers for an earnings slowdown for months:
The stock market will narrow in the upcoming weeks, and institutional investors will focus their attention on stocks that can maintain strong earnings and sales growth in a decelerating environment.
Personally, I expect that the S&P 500 will beat analyst expectations and continue to post positive earnings in the first quarter. But investors will still face a huge challenge: Identifying which stocks will sustain strong sales and earnings momentum.
The stock market will chase fewer stocks going forward and will essentially form a “funnel” that diverts funds to stocks with the strongest sales and earnings growth.
The bottom line: We are now entering a stock picker’s market. I expect the fundamentally weak stocks that have been propelled higher by index funds to falter in the upcoming weeks, especially as the pension funding season ends, first-quarter earnings season commences and index buying pressure ebbs. As a result, the stock market will narrow and it will soon be “every stock for itself.”
So, this anticipated earnings decline shouldn’t come as a huge surprise. But on this point, let me ask you a question …
***What is it that moves a stock’s short-term market price?
If you piggybacked on Louis’ analysis and answered “strong earnings growth” or some version of that, you’re almost right, but not quite …
Earnings, or rather a company’s earnings growth, drives a stock’s longer-term market price. But in the short-term, it’s something else …
Surprises to earnings expectations.
For instance, if analysts are calling for $10/share of earnings, but that number comes in at $8/share, that underperformance is going to take the market by surprise. Expect a sell-off.
However, let’s say analysts were actually expecting a loss of $3/share, but that number came in at a loss of just $1/share. This time around, the surprise was positive. The stock will probably surge.
This makes some people scratch their heads — the first company profited $8/share yet its stock dropped, while the second company burned through $1/share, yet its stock rose. But it goes to underscore the reality that earnings themselves aren’t the driver of short-term prices — it’s surprises to those earnings expectations.
***So, where are we in regards to earnings expectations for Q1?
The phrase “in the toilet” comes to mind.
According to FactSet:
In terms of estimate revisions for companies in the S&P 500, analysts have made larger cuts than average to EPS estimates for Q1 2019 to date. On a per-share basis, estimated earnings for the first quarter have fallen by 7.2% since December 31. This percentage decline is larger than the 5-year average (-3.2%), the 10-year average (-3.7%), and the 15-year average (-4.0%) for a quarter.
In addition, a larger percentage of S&P 500 companies have lowered the bar for earnings for Q1 2019 relative to recent quarters. Of the 107 companies that have issued EPS guidance for the first quarter, 79 have issued negative EPS guidance and 28 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 74% (79 out of 107), which is above the 5-year average of 70%.
Here’s how this negative guidance looks on a chart. Basically, a sea of red:
So, according to the financial media and respected research groups like FactSet, Q1 earnings are going to be rough.
But if that’s the expectation — which is now widely embraced and saturating the headlines — how shocked can the market actually be if/when it happens? And if the answer is “not that shocked,” then might it be fair to expect any selloffs to be somewhat limited and short-lived?
***Second, let’s expand our view to what may come after Q1
If you’re anticipating a brutally-cold winter, does that mean you should sell all your summer clothes?
Of course not. Yes, the winter might be frigid, and perhaps longer than you’d like, but it won’t stay frigid forever. With that in mind, what are analysts saying for the rest of 2019?
According to FactSet, earnings growth will swing back into the black in Q2 with growth of 0.1%. For Q3, growth climbs to 4.3%. And to round out 2019 in Q4, earnings estimates are projected to rise to 8.3%. So, yes, there will be a spring after this winter.
***Of course, this is not an excuse to keep weak stocks in your portfolio
Just because earnings growth is likely to pick back up as 2019 unfolds is no reason to ignore analyzing your portfolio for companies that may no longer deserve to be there. If a stock you own is showing deteriorating earnings, then you should sell it or identify a reason that suggests it’s still worth holding.
If you’re not sure where to begin in conducting this type of analysis, Louis Navellier can help. As I wrote in our March 15th Digest, Louis provides his Growth Investor subscribers a free report called “8 Plunge Protection Steps to Thrive in Market Selloffs.” One of these eight steps applies equally well to analyzing a company’s fundamental strength.
He points toward sales growth, operating margin growth, earnings growth, earnings momentum, earnings surprises, analyst earnings revisions, cash flow, and return on equity.
If you analyzed all these factors for every stock in your portfolio, it could take a long time. But did you know that Louis offers this service — for free? It’s called the “portfolio grader” and it evaluates a company by the metrics I just identified, revealing a composite score.
For instance, here’s a screenshot of the results for Apple:
Growth Investor subscribers can even log in to see the specific grades a company receives for each of Louis’ metrics.
Wrapping up, all signs are pointing toward a challenging Q1 earnings season. But, because “all signs” are pointing this way, that ho-hum expectation should help soften the impact on the broader market if/when it happens.
That said, some stocks with truly bad earnings will be hurt. To keep your portfolio in its best shape, it’s important to analyze your holdings to be sure you’re not holding one of those underperformers. Feel free to use Louis’ free grader to help you with this.
After all, a few minutes of research today could protect you from a lot of portfolio pain tomorrow.
Have a good evening,
Jeff Remsburg
