As Sam Sees It: Can Q1 Earnings Beat Drastically Lowered Expectations?

Sam Stovall |

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: Wednesday marks the official start of the second quarter, and it couldn’t come soon enough as investors dealt with a little scare in Q1. The S&P 500 barely managed to eke out a small gain to keep its streak of positive quarters alive. What is the significance of this achievement?

Stovall: The first quarter did end up rising less than 1%, and I think some investors may not think that’s something to get excited about. However, it was the ninth straight quarter of price gains, and only three other times since World War II did we have at least nine straight quarters of price advances: 1953 into 1956, 1962 into 1965 and then 1995 into 1998.

In each of these prior periods, we saw that they went on to record their 10th straight quarterly advance with an average price increase of about 8%. Now, that’s not a level that I’m willing to forecast right now, but it’s certainly encouraging that it doesn’t necessarily mean that after nine straight quarters that it traditionally comes to a close. There’s still some life left in the market

EQ: April is historically one of the best months for the market. What favorable historical trends can investors look to here?

Stovall: It’s sort of funny. I like to say that like most middle children, the second quarter of the year tends to get overlooked. Since WWII, the S&P 500 recorded an average price increase of 1.9% in the second quarter and it rose 61% of the time. Drilling down a little bit further, some people like to point to T.S. Eliot, who wrote that, “April is the cruelest of months.” While that may be true, it doesn’t necessarily apply for the stock market because the cruelest of months actually occurs in September for stocks.

April is actually the second best month only to December in terms of average price increase. The S&P 500 has gained about 1.5% on average in April as compared to about 1.8% in December. Also, the frequency of advance has been very strong at nearly 70% for all Aprils as compared to the 78% in all Decembers since WWII. So I guess April is a month that investors like to ignore, but if you look to large caps or even small caps—through the Russell 2000 and the S&P SmallCap 600—we find that April is indeed the second best month. So that gives us something to look forward to.

EQ: As you noted in this week’s Sector Watch, the market’s ability to produce a positive quarter in the face of quite a bit of headwinds was somewhat impressive. How many of those obstacles will carry into Q2?

Stovall: When you think about what happened in Q1, ending up with a positive return was fairly impressive. We had very foul weather that occurred in February that dumped record amounts of snowfall across much of the country. We also saw a shipping strike on the West Coast that pretty much grounded a lot of imports to a halt, and that spanned most of the quarter. We saw an 8% increase in the value of the US dollar, therefore making exports less attractive to foreign buyers. GDP growth was only 2.2%, which was worse than the expected gain of 2.4%. Then finally, expectations now are for a 3.0% decline in operating earnings for the S&P 500 for the first quarter. That will be the first decline in earnings since 2009. So there were a lot of headwinds that investors had to face.

However, if we look to what’s likely to happen in the second quarter, I think a lot of these things are just not going to be happening. I don’t expect to have any record snowfalls this spring, and I certainly don’t expect us to be having a similar problem with shipping on the West Coast.

We are expected to see earnings come down about 2% in the second quarter, so that could still pose a bit of a challenge. Maybe we see some digestions of gains in the dollar, which would allow investors to breathe a sigh of relief. So maybe in the second quarter we end up having a little better return and fewer headwinds than we did in the first quarter.

EQ: Earnings season for Q1 is right around the corner and as you just said, we are currently expecting to see a lot of red. That’s on top of what we discussed last week in that estimates for 2015 earnings growth have really come down. What are you watching for during this coming reporting period to get a gauge on the market?

Stovall: Well, we all know how low the bar is for the first quarter. Now the question is whether companies will beat those lowered expectations by anywhere from 2 to 4 percentage points like they have in the past. If we end up outperforming the earnings expectations by the upper-end of that range, we could go from a minus 3% to a positive 1%, which could keep at bay the prospects of a profits recessions. So I think we want to see how the actual numbers for the first quarter come through.

Second, we want to look for the kind of guidance companies are offering, if any, for the second quarter or for the entire year. Again, history says but does not guarantee that usually profits recessions precede general recessions. So now in a sense, we have to wonder if we have to worry about the overall economy, or is this simply like three other times since WWII in which we saw profits decline but did not drag down the overall economy.

EQ: What are the chances that companies might use this quarter as a dumping ground for write-offs to set themselves up for stronger quarters going forward?

Stovall: Well, usually the kitchen-sink quarter is the fourth quarter of a particular year, but companies still have to be very careful about how much they write down because they could adversely affect their loan covenants that they have to maintain, earnings streams, and things like that. In a sense, that could end up coming back to haunt them if they are too aggressive in writing down their earnings.

Other aspects of the business might conclude that maybe these companies are not as safe a bet as they originally anticipated. So there could be some hidden pitfalls that could come from being overly aggressive.

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