10/07/15   Are You Ready For Poor Earnings?

Editor’s Corner

Ron Rowland

Another earnings season is getting under way, and according to Thomson Reuters, it may not be a good one. The S&P 500 companies are expected to report a year-over-year profit decline of 4.2% on a revenue decrease of 3.5%. The dividend-adjusted, one-year return for the S&P 500 stands at +2.5%, so if you believe quarterly earnings prospects drive the market, then the S&P 500 is not properly reflecting the current outlook.

As usual, there will be winners and losers, and the stock market’s reactions will not be based on what is reported as much as on what each company has to say about its outlook for the fourth quarter and 2016. The future is more important than the past. However, understanding past results and contributions can still be beneficial.

On a sector basis, Telecommunication Services should be the winner with an expected 11.4% increase in profits. Consumer Discretionary is close behind with an 11.3% gain. Although their profit increases are expected to be nearly identical, the performance results for these two sectors over the past year are quite different. Telecom is showing a one-year decline of 3.4% while Consumer Discretionary is posting a 16.4% gain. One-month returns tell a similar story with Telecom losing 2.4% while Consumer Discretionary gained 2.8%.

It’s obvious that more than just third-quarter earnings estimates are driving stock prices. Three other sectors are expected to announce year-over-year profit gains. These are Financials with a hefty 9.7% jump, Health Care with a 4.3% increase, and Technology making the cut with a 2.5% gain. The Health Care sector has been taking a beating recently, but it hasn’t been due to the upcoming earnings announcements.

This leaves five sectors with excepted profit declines. These include Utilities -2.4%, Consumer Staples -3.3%, Industrials -3.7%, and Materials -15.4%. The magnitude of the shortfall in Materials is much larger than the others mentioned. However, there is still one more on the list, and that is Energy. The Energy sector has been battling falling crude oil prices for a year now, and its year-over-year profit change is expected to be a whopping 64.6% decline.

The Energy sector profit shrinkage is so large that many news outlets are reporting that the S&P third-quarter profits are expected to be +3.2% higher if you exclude Energy. Low cost energy should be a boon for companies in the Utilities and Industrials sectors, but so far that does not appear to be the case. Additionally, prolonged lower oil and gas prices will force the Energy sector to reduce expenses, and that means more layoffs.

Investor Heat Map:10/7/15

Sectors

Three sectors flipped from red to green this week and marks the first time in seven weeks that green pixels have appeared anywhere on these charts. Utilities, Real Estate, and Consumer Staples constitute the trio making this transition, after being the three highest ranked categories a week ago. Real Estate, which will become a formal GICS sector in 2016, has been trying to establish itself as a “defensive” sector during the recent pullback. Historically, Health Care has joined Utilities and Consumer Staples in the defensive classification, but today Health Care is at the bottom of the rankings. This should be a good reminder that historical tendencies do not equate to future guarantees. Consumer Discretionary was also able to hold its same ranking position as last week, but unlike the three higher ranked sectors, it was not able to shed its negative momentum. Technology, Industrials, Energy, and Materials all climbed with Energy posting the largest improvement. Financials, Telecom, and Health Care dropped in the rankings with Telecom falling four places. Health Care only fell two places, but that was probably due to the fact it couldn’t fall any further. Health Care was in first place ten weeks ago, and now finds itself at the bottom in a position it hasn’t occupied in many years.

Styles

The style rankings are aligned in their defensive pattern. For style-boxes, taking on a defensive posture means the blue-chip stocks of the Mega-Cap classification are on top with the three Large-Cap categories sitting in second through fourth. This alignment was accomplished by Large-Cap Value and Small-Cap Value swapping places since our prior update. Last week, Small-Cap Value was identified as an anomaly after climbing six places and separating itself from the other small capitalization categories. This week’s changes starts to rectify this anomaly, although it is still visible with Small-Cap Value wedged between two Mid-Cap categories. Small-Cap Blend, Micro-Cap, and Small-Cap Growth constitute the bottom three style categories for the second week running.

Global

The global stock market rally of the past week resulted in improved momentum scores across the board. However, the intermediate-term downtrends were so steep that they all remain negative. The US is at the top for the sixth consecutive week, and World Equity is enjoying its third week in second. The UK climbed three spots, effectively swapping places with Japan. EAFE and the Eurozone exchanged places while remaining sandwiched between the UK and Japan. Emerging Markets inched two spots higher, and it pushed Canada and Pacific ex-Japan each a notch lower in the process. China and Latin America posted big weeks, but they are still on the bottom.


Note:
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.

 


“Definitely China not buying as much raw materials is hurting a lot of these companies.”

– Gregory Harrison, senior research analyst at Thomson Reuters on the outlook for 3Q earnings in the Materials sector


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