04/06/16   It’s Not the Estimate but the Surprise

Editor’s Corner

Ron Rowland

If the stock market reflected the latest earnings estimates, then stock prices would be far below the near-record highs of today. The calendar says we are now in early April, and that means the Q1 earnings season is about to get underway in force. The accompanying chart from Thomson Reuters Institutional Brokers’ Estimate System (“I/B/E/S”) shows the aggregate earnings growth estimates for the S&P 500 companies and each of its 10 major sectors. All but three of the numbers are negative—analysts are not expecting a good quarter.

Thomson Reuters I/B/E/S

Starting with the entire composite, overall earnings are expected to drop by 7.4%. This is on top of the actual 2.9% decline for the fourth quarter of 2015. Revenues are expected to be only 1.2% lower, so analysts are factoring in higher expenses. Consumer Discretionary is the brightest spot on the chart, with estimates showing a hefty 13.3% growth in earnings on a projected 5.3% gain in revenues.

Telecom Services companies are expected to post a 5.0% improvement in earnings. This follows a 21.6% jump in the fourth quarter, which helped make Telecom the earnings growth winner for 2015. Health Care is the third and last sector expected to post an earnings improvement for the quarter. Despite back-to-back quarters of earnings gains, the stock performance of the Health Care sector has been dismal for six months.

Consumer Staples, Utilities, Industrials, and Technology are all expected to report modest declines in earnings. Declines are never welcome, although investors have learned to live with the fact that they do indeed happen. The 5.4% drop for Technology would not be considered “modest” in most quarters because the setback is expected to be its largest since the Great Recession. However, the Technology sector earned that adjective this quarter because its expected drop should be 2% better than the overall S&P 500.

The Financials sector continues to struggle in the low-interest-rate environment, and the 20% plunge in the earnings for Materials is due to continuing weakness in commodities.

The elephant in the room is Energy. You may be wondering how something can drop more than 100%. Unlike stock prices that cannot go below zero, earnings can and do. After getting its earnings slammed in 2015, the Energy sector is expected to see its minuscule profits turn into a loss for the first quarter of 2016. Energy company stock prices have been declining for nearly two years in anticipation of a loss becoming a reality. The last time the Energy sector posted a loss was 14 years ago.

Whenever there is a large outlier, analysts want to know how the composite would change if the outlier were to be excluded. Excluding Energy from the first-quarter estimates does help, but they would still decline by 2%. This clearly shows that Energy is not the only problem.

As previously mentioned, stock prices are not determined by earnings estimates. They do have an influence, but for the most part, these estimates are already baked into current prices. Instead, look for earnings surprises and the company’s outlook about the remainder of 2016 for real clues about stock and sector performance.

Investor Heat Map 4/06/16


Telecom jumped three spots higher to retake the top sector ranking it held four weeks ago. Utilities, the interim occupant, slid down a notch to second. Real Estate held steady in third, and the rise of Telecom pushed Materials two spots lower. Technology and Consumer Staples remained a closely coupled pair and moved ahead of Industrials. Consumer Discretionary continues to languish in the lower half despite recent strength among homebuilders. Financials lost some momentum but managed to improve its ranking due to the more pronounced weakness in Energy, which dropped two spots to last place. Health Care finally made the transition from red to green, registering its first positive momentum score since the first week of January.


Mid-Cap Value and Mid-Cap Blend extended their reign at the top to a fourth week. The next grouping of style categories closely resembled a six-way tie a week ago, which led to significant shifts in their relative positioning this week. Large-Cap Growth moved to the top of this group, and Mid-Cap Growth followed. Mega-Cap also posted an improvement. These advances came at the expense of Small-Cap Value and Large-Cap Value, which each slipped four spots lower. Although the dispersion in momentum scores has increased slightly this week, these six categories in the middle all remain with four points of each other. As such, it would be premature to declare that Growth has retaken the leadership mantle back from Value. The bottom three categories remain the same. Small-Cap Blend, Small-Cap Growth, and Micro-Cap were all able to increase their momentum this past week, yet they continue to trail the field.


Global weakness is evident as four categories turned negative, breaking away from the unanimous lineup of positive momentum scores a week ago. Japan is the primary culprit, swinging from a slightly positive trend to a double-digit negative momentum score. It fell back into last place, and its poor results occurred despite a huge 9.6% surge in the Japanese yen since the end of January. Currency-hedged Japan funds have performed even worse, with the WisdomTree Japan Hedged Equity ETF (DXJ) showing a 19% loss for the year. The Eurozone, EAFE, and the U.K. were the other three categories to slip back to red today. Renewed weakness in the U.S. dollar over the past two months would normally provide a boost to foreign categories, but the U.S. has defied conventional wisdom by climbing a notch against its foreign competitors this week. Although there are no changes among the top-three ranked global categories, they all posted momentum declines. Latin America remains heads above the crowd and has a comfortable command of its leadership position. Canada and Emerging Markets retained their second- and third-place spots, respectively. Pacific ex-Japan, the former fourth-place occupant, slipped two places to sixth. Again, this weakness developed despite the category receiving a significant currency translation boost.



The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“The economy here is not growing fast. A lot of the companies in the S&P 500 are kind of dependent on international growth, and that’s slowing down.”

Greg Harrison, analyst at Thomson Reuters


© 2016 Dynamic Performance Publishing, Inc. – All Rights Reserved. This material is protected under U.S. copyright law and is provided for the exclusive use of our members for personal purposes. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by Dynamic Performance Publishing or our employees to you should be deemed as personalized investment advice. Any investment recommended in this email should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. Dynamic Performance Publishing, its affiliates, and clients may hold positions in the recommended securities. Results are not indicative of holdings for clients of Flexible Plan Investments. Forwarding, copying, or otherwise duplicating this information for the use by anyone other than the intended recipient is expressly forbidden. Any retransmission of this material by you is your authorization to us to debit your credit card, or otherwise bill you, for a full price one-year membership for each violation. It may also cause your membership to be revoked without a refund. Any such action on our part does not prevent us from seeking additional legal remedies.