Consensus Calls for Bleak First-Quarter Earnings

Low expectations could set the stage for some upside surprises as earnings season kicks off this April

by Bernie Schaeffer

Published on Mar 25, 2019 at 8:52 AM

The following is a reprint of the market commentary from the April 2019 edition of The Option Advisor, published on March 22. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.

Following Wednesday's "no hike" decision from the Federal Open Market Committee (FOMC), in which the policy-setting body released a forecast predicting it doesn't expect to raise rates for the remainder of 2019, investors now face a relatively lengthy drought before they can expect any major Fed-related action. The two-day FOMC meeting scheduled for April 30-May 1 is unaccompanied by a planned press conference, which means we're unlikely to see any major policy changes, or adjustments to the central bank's outlook, until as far out as the June 18-19 summit.

In the meantime, we'll have to rely on some "old-fashioned" catalysts for stocks -- trade war headlines; general Brexit disarray; tweets from the likes of Trump and Musk; and the familiar standby that is corporate earnings season. As of this writing, we're a little less than a month away from the floodgates opening on first-quarter reports, which could be a key driver of equity moves as the second quarter of 2019 gets rolling.

In terms of catalysts, earnings season can hold its own with even the most high-profile interest rate decision -- even in the post-December 2015 era of the seemingly almighty tightening Fed. Schaeffer's Senior Quantitative Analyst Rocky White collected the data in the table below, which shows that the SPDR S&P 500 ETF Trust (SPY) tends to average a one-month return of +1.20% following the start of earnings season. That compares to an average return of -1.16% in the month after a Fed rate hike, and a mean +1.26% return following a Fed meeting with no change to interest rates. Collectively, all of these average one-month returns roughly double the magnitude of SPY's "anytime" one-month return of 0.67% since 2015.

And turning our focus to directional moves, earnings season has tended to be a net positive driver for SPY in the most recent Fed policy-tightening era. The average one-month return after the start of earnings season is 1.20% with 76.5% positive returns, which is right on pace with the post-"steady Fed" average return of 1.26% (75% positive).

spy returns post-fed vs post-earnings

As we look ahead to the coming onslaught of first-quarter earnings, it's worth pointing out that expectations are extremely low for the upcoming wave of corporate results. According to the most current FactSet data, analysts are expecting earnings for S&P 500 companies to fall 3.6% for the quarter -- which would represent the first year-over-year decline since the second quarter of 2016. Only four sectors (out of 11) are expected to manage year-over-year earnings growth, and two of those four are the traditionally "defensive" utilities and healthcare groups.

Furthermore, analysts have downwardly revised their S&P per-share earnings estimates by 6.7% since Dec. 31. The magnitude of those cuts approximately doubles the five-year average of 3.2% for the quarter, and the 10-year average of 3.7%, per FactSet. The sectors expected to report the biggest earnings declines are energy, materials, and information technology.

Analysts' downbeat forecasts for first-quarter profits doesn't come out of the clear blue sky, of course. Fourth-quarter conference calls included cautious comments on trade, tariffs, and the government shutdown, and FactSet reports no fewer than 73% of S&P companies that issued first-quarter guidance provided a negative outlook.

And the fundamental backdrop has shifted in non-trivial ways from a year ago. Analysts were fairly upbeat ahead of the release of first-quarter results in 2018, with one Bloomberg article noting at the time, "Strategists from JPMorgan and Deutsche Bank have expressed confidence, citing everything from a weaker dollar to stronger global growth and buybacks as reasons S&P 500 earnings will surpass estimates by as much as 5 percent." As Schaeffer's Senior V.P. of Research Todd Salamone observed over email earlier this week, "It strikes me that the exact opposite is now in place, with respect to global growth and the U.S. dollar."

Having said that, we'd point out (from our usual contrarian viewpoint) that there are worse things than dramatically lowered expectations heading into earnings season. This naturally creates opportunities for positive reactions, upside surprises, and a bullish unwinding of skepticism -- even in the wake of what would normally be considered "less than stellar" results. But with several weeks to go until first-quarter earnings reports begin to roll out in earnest, we advise keeping a close watch on broad-market sentiment measures -- such as equity-only put/call volume ratios, weekly investor bull/bear surveys, and composite short interest levels -- to make sure undue optimism doesn't begin to creep in, potentially dampening any cumulative earnings-related boost for stocks.


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