As Sam Sees It: High Stakes and Low Expectations for Q1 Earnings

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: As you've stated before, expectations for first quarter 2012 earnings are very low, with estimates for an increase of under 1 percent. In 2011, Q1 EPS saw an increase of just under 20 percent. Why is there such a big drop-off in expectations?

Stovall: First off, it's because we are proceeding in a very weak economic expansion. Usually in the early phases of an economic recovery, earnings tend to recover most quickly. We are now in record territory in earnings, whereas the same cannot be said about share prices. But even though we have seen a V-shape recovery in corporate earnings, the pace of the advance in earnings is slowing because of the lackluster economic growth domestically, combined with a recession that we believe is currently occurring in Europe. So Europe being slower, the emerging markets therefore are also being slower because emerging markets export a lot to Europe. As a result, their economic growth is waning. That all basically has a depressive impact on earnings around the globe. Currently, we're are expecting 0.96 percent growth in year-over-year operating earnings, and six of the 10 sectors in the S&P are projected to show year-over-year declines.

EQ: Industrials is expected to post the largest increase by a fairly wide margin. Can you talk about some of the major drivers there, and some sub-industries that are expected to lead?

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Stovall: Despite the uncertainties of global economic trends that I mentioned, we think that generally, improving conditions will be a major factor behind the expected increase. We also believe that the gains will be driven by favorable demand in emerging markets even though they too are seeing a bit of a slowdown. Specifically, we expect robust gains in Construction Equipment, where demand is being boosted by strong levels of infrastructure spending in the emerging markets and the need to replace aging equipment in developed markets. As a result of high oil prices and growing business confidence, we see Construction and Engineering companies being aided by a likely pickup in capital spending on upstream oil projects, and more feasibility studies across several industries including Oil and Gas.

Finally, we think that Logistics companies will benefit from improved export activity in Asia and increased document deliveries related to an improving domestic economy.

EQ: Inversely, Materials is expected to be the biggest laggard with a decline of over 16 percent. What are some of the challenges that his sector faces?

Stovall: The S&P 500 Materials sector is expected to show a 16-percent decline in year-over-year operating results in the first quarter. Likely contributors to the projected decline are diversified metals and mining producers, given weakness in copper prices, iron ore, and metallurgical coal. Aluminum producers and producers of fertilizers should see declines on weak pricing and cost pressures. While paper and forest products companies they also feel the impact of continued carryover from weakness in Europe.

EQ: Aside from quarterly performance, another important factor to pay attention to is guidance provided by the companies. What are you looking for here?

Stovall: Guidance is something that people desire but rarely get satisfied by, mainly because companies don't want to commit themselves to future quarters, whereas they feel pretty good that they can manage existing quarters. The reason why guidance is especially important this year is because the first two quarters of 2012 are expected to show growth below 2 percent, whereas the fourth quarter is expected to show earnings growth in excess of 15 percent. So guidance is going to be very important since this is a back-end loaded year. We need to make sure that earnings will come through because otherwise a lot of investors’ anticipation is unfounded.

EQ: The S&P 500 has been trading around 1400 over the last few weeks. Would better or worse guidance have any implications on your target level?

Stovall: S&P's Investment Policy Committee recently raised our 12-month target to 1450 from 1400. I think that a lot of that has to do with the passage of time as well as future earnings expectations, combined with current multiples for the stock market. But obviously, if guidance ends up being weaker than as currently anticipated, then I think that it would make it more challenging for us to meet that 12-month target.

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