As Sam Sees It: Why Investors Shouldn’t Be Discouraged By Q1 Weakness

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.

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EQ: The S&P 500 endured a three-day slide right as Q1 earnings was set to begin. It’s managed to stabilize so far. What do you think caused such a sell-off in the market ahead of the earnings reporting season?

Stovall: It’s a combination of things. First, when you look at what’s going on geopolitically, there’s still tension between Russia and Ukraine. Then there are questions about the economic growth for China this year, and prospects of higher interest rates. Of course, there are also worries about the bull market, which is in dire need of catching its breath and going through some sort of a correction.

Obviously, investors are also very concerned about the first quarter reporting period. In the very beginning of 2014, according to S&P Capital IQ consensus estimates, Wall Street analysts were forecasting a 5-percent increase in Q1 operating results. Now, it looks as if we’re going to get something along the lines of 0.5 percent. That’s one-tenth of what we thought we would get. So that’s causing a bit of concern for investors, in addition to the worries that they already had.

EQ: Looking at Q1 expectations, it's anticipated to be the weakest quarter this year by far. How much of this had to do with the winter weather, considering that expectations have been reduced by so much? How much of it is related to other factors?

Stovall: I think a lot of it had to do with the winter weather. Our chief U.S. economist Beth Ann Bovino had reduced her first quarter GDP growth estimate from 2.2 percent down to 1.9 percent, primarily because of weather. I think the real question is whether March will be as weak as January and February. That sets us up for the potential of a bit of a surprise when the Q1 GDP numbers come out.

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Second, what kind of an impact or cascading effect will this weaker-than-expected GDP growth have on corporate earnings? Or is it just a very easy excuse for corporate executives to use to help guide earnings lower? I feel that the bar is set so low that an investor would be better off learning to do the limbo than the high jump to get a much clearer picture of what this first quarter reporting period is going to be about.

EQ: Earnings are expected to rebound in a big way in the subsequent quarters. What are some of the broader economic drivers of that bounce-back?

Stovall: S&P Capital IQ estimates that the second quarter will be up 8.5 percent, up 6.0 percent for the third quarter, and up 11.0 percent for the fourth quarter. That translates into an advance of 7.4 percent. Really, it’s just a very good earnings year that will likely be dragged down by the first quarter results.

The trajectory of consumer spending continues to be slightly higher, and the same with U.S. and global GDP growth. The expectation is for an improvement in capital expenditures, and I think that even though the pace is what everyone would’ve liked, we continue to see a slight improvement in the jobs picture.

In addition, I think the companies are doing a good job of controlling costs and purchasing back shares. So when you also add in the expectation that revenues will probably be up by 4 percent or more as the year progresses. Right now, the first quarter is expected to grow by 3.7 percent, but expectation for the fourth quarter is 4.4 percent. So it’s not just a cost cutting and share repurchase impact on earnings. Revenues too, are expected to show improvement.

EQ: Looking at how drastically the Q1 numbers were reduced, is there a high probability that might occur for the upcoming estimates?

Stovall: Last year at this time, the expectation was for a full-year gain of more than 10 percent, and we ended up under 6 percent for all of 2013. So here we are at the beginning of 2014, and maybe this 7.4 percent growth—which had been 10 percent as of the beginning of January—ends up getting trimmed as well. So there could be a bit of a concern because we’ve done some drastic trimmings before any major companies have even reported Q1 results.

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