Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
EQ: The start of first quarter earnings reporting season is now officially underway. Based on expectations and corporate guidance, there is an outside risk that this could turn into troughing quarter for the current bull market. If that does happen, what kind of implications will that have on the market?
Stovall: According to S&P Capital IQ consensus earnings estimates, it now appears as if the market will post a 0.7 percent year-over-year increase in first quarter operating earnings as compared with the prior trough in the second quarter of 2012, which was a gain of only 0.9 percent. I think just as investors looked beyond that trough, and looked toward improving earnings over the next couple of quarters, investors are pretty much doing the same thing. By listening very closely to company’s earnings reports, they want to see what kind of guidance they can receive for the second quarter as well as the rest of the year to ensure that we are again likely to be ramping up rather than slipping back into a weakening earnings environment.
EQ: One of the concerns you presented in this week’s Sector Watch report is that perhaps Wall Street has grown accustomed to managements’ ability to essentially game expectations lower. Do you think this could pose a significant problem for investors sooner or later?
Stovall: Investors and analysts realize that corporate management does do a very good job of managing expectations. They’re not necessarily crying wolf–which is probably a phrase better left to describe Congress–but as a result of this practice, earnings usually end up beating estimates by a shade of a penny or two. Last quarter, Capital IQ reported that 65 percent of companies in the S&P 500 beat expectations versus the 10-year average of 62 percent. You might be thinking that if Wall Street analysts are paid to come up with good estimates for companies, then why do so many of them beat expectations? The main reason could be that companies themselves don’t even know what earnings are likely to be until they put all the numbers together. Still, depending on when the company reports, they might end up trying to aggressively manage expectations so that they have the ability to beat earnings estimates by a penny or two.
EQ: Is this trend a result of the current economic environment or is this sort of a new normal in the sense that expectations will be pegged to low guidance going forward?
Stovall: I don’t think that company management guiding expectations lower is a modern day phenomenon. Management has been doing this for years, and I don’t really see it being very different going forward. Basically, companies would like to smooth the trends in volatility surrounding stock performance once earnings have been reported, and everybody would prefer that you have a little bit of improvement. Some companies might offer guidance a day before they announce where they suggest analysts lower their expectations, and they come out the next day and end up beating by a penny. Does that really count? Or should everything be cut off at the end of a quarter? But I don’t think it’s a new phenomenon, it’s just part of how the earnings game is played.
EQ: This quarter, the high performers are expected to be the two Consumer sectors as well as Telecom. Can you talk about what S&P Capital IQ is projecting in these areas?
Stovall: Expectations are that we’re going to see good earnings growth for Consumer Discretionary, which are the stocks in the auto, homebuilding, and retailing areas. The feeling is we’ll probably see a 9-percent increase in earnings, and the optimism is pointed to the improvements in auto sales and the housing market, as well as share buybacks and M&A activity, combined with low interest rates that are benefiting the sector. For Consumer Staples, which is expected to be the third-best grower this quarter at 4.4 percent, will likely benefit from moderating commodities cost pressures, restructuring and cost reductions, as well as stock repurchase programs. At the same time, they could be partly offset by the strengthening of the U.S. dollar and some continued softness in volume sales.
The best-performing sector will likely be the Telecom Services area, where our initial growth estimates were for 9.6 percent. Mainly, you can point to the wireless side of the telecom services area where the carriers have been upgrading subscribers to smartphones and converting them to a family of device data plans that will likely increase revenue and earnings per user. Those are the three that are likely to be the best performers in this first quarter.
EQ: Materials is expected to edge slightly higher in EPS growth in the first quarter, but projected to take off the rest of the year, especially in the second half. What are some of the anticipated drivers for that sector’s rebound?
Stovall: What we’re seeing right now is that overseas demand has been a bit tepid. I think as people worry about the ongoing recession in Europe, they question the soft landing in China, and it’s really a picture painted by an improving economic outlook for the remainder of this year. U.S. economic growth is expected to be up in the 3 to 4-percent area on an annualized basis come the second half of the year. The expectation is also that China will end up growing by more than 8 percent this year after rising in the mid-to-low 7 percent area in 2012. So in general, it’s the expectation for an improved global environment.
Read Next
