Godot Arriving for Bulls Waiting to See S&P 500 Profits Turn

  • Upward guidance hits four-year high against lower forecasts
  • Confidence in contrast to rampant skeptimism among investors

Waiting for a rebound in earnings has taken on elements of absurdist theater for stock market bulls. Now a measure of corporate optimism is signaling Godot is on the horizon.

Companies from DuPont Co. to St. Jude Medical Inc. that say profits will exceed analysts’ estimates just outnumbered those warning earnings will trail forecasts for the first time in four years, data compiled by Bloomberg show. Globally, a separate measure shows upward revisions in net income are outpacing reductions at the fastest rate since the financial crisis.

While neither proves an end is at hand to the year-long slump in S&P 500 profits that has brought the U.S. bull market to a standstill, the improvement is a rare glimmer of hope for bulls contending with weakening global growth. Comparable gains in company guidance have portended higher equity prices since 1999, with the S&P 500 climbing an average 5.5 percent a year later.

“Knowing full well that these people are incentivized to manage expectations downward so they can under-promise and over-deliver, you have to take it as a positive,” said Joseph Tanious, an investment strategist at Bessemer Trust in Los Angeles, which oversees more than $100 billion. “They’re running the company, living and breathing it every day.”

Oil, Dollar

What could be causing the brightened outlook? Prospects for oil companies have stopped getting worse after crude staged a 61 percent rally from a 12-year low just above $27 a barrel in February, though it remains about 59 percent below its peak in 2014. The dollar, whose 25 percent jump from mid-2014 to January has weighed on sales for multinational firms, fell for a third straight month in April and touched a one-year low last week.

Business optimism is in stark contrast to souring sentiment among investors, who’ve been hoarding cash, pulling money out of mutual funds and selling stocks short. Bearishness has been snowballing ever since the S&P 500 suffered two 10 percent corrections that were less than three months apart, a bout of volatility that has only occurred one other time in bull markets dating back to the Great Depression.

The stock gauge rose 0.1 percent at 4 p.m. in New York after capping a second straight weekly retreat.

According to results from 87 percent of the S&P 500, income in the January-March period dropped 7.9 percent from a year ago, the worst quarterly decline since 2009 when the bull market began. Analysts expect the string of decreases to last through June before earnings finally start rising again in the three months ending in September.

The problem is, such a recovery has been pushed back every quarter since the middle of last year, and until now there’s been little to suggest anything but pessimism was warranted. Since June, analysts have cut earnings forecasts by an average of 5.3 percentage points between the beginning and end of each quarter.

DuPont and St. Jude Medical are among 107 companies that in the last four weeks have projected income above analysts’ estimates, compared with 122 that provided lower forecasts. The guidance ratio reached 1.02 on April 27, the highest since April 2012 and a departure from the first three months of the year, when downward guidance outpaced upward by 2-to-1.

“Part of the positivity is a relative reaction to the pessimism that they had, probably rightfully so, into the beginning of the year,” said Christian Magoon, chief executive officer of Amplify Investments in Wheaton, Illinois. “In the short term, the market is a little more like a popularity contest. It’s about sentiment, emotions. Over the long term, growth in earnings and fundamentals win.”

Turning Point

Similar improvements have occurred eight times since 1999 and all but two saw stocks posting gains 12 months later. In the one instance where the ratio broke above 1 and profits were declining as they are now in 2002, S&P 500 earnings recovered in the next quarter, with the expansion rate increasing by 9.7 percentage points.

A pause in the drumbeat of bad news on earnings would be welcome by bulls who’ve watched stock swings widen and rallies die as share prices approached levels reached 12 months ago. A doubling in corporate profits between 2009 and 2015 underpinned a 215 percent rally in the S&P 500 that restored $17 trillion to share values. At the same time, earnings declines of five quarters or more have almost always coincided with a recession.

“Investors are now very much taking the ‘show me the money’ approach,” said David Stubbs, a London-based global market strategist at JPMorgan Asset Management. His firm oversees about $1.7 trillion. “They don’t just want CEOs to tell them that earnings will improve. They want hard evidence.”

Global Trend

It’s not only in the U.S. that earnings sentiment is improving. A Citigroup Inc. index that tracks analysts’ profit upgrades versus downgrades worldwide has climbed to a one-year high after dipping in January to the worst level since 2009.

A profit recovery would ease pressure on valuations that have risen to a six-year high even as stocks have gone nowhere in the past 12 months. At 19 times earnings, the S&P 500’s multiple sits 15 percent above its 10-year average.

The Federal Reserve and the Treasury market are sending no signals that match the positive ones in guidance, said Crit Thomas, a senior investment strategist at Touchstone Investments in Cincinnati, where the firm oversees $15 billion. The central bank last month said it will proceed gradually in raising interest rates amid slow growth in the economy. In the bond market, yields on 10-year Treasury notes have been stuck below 2 percent since January.

“I take the guidance with somewhat of a grain of salt,” Thomas said. “It’s nice to see the trend, but if you look at the dovishness that the Fed came out with and what Treasuries are doing, they’re painting a different picture.”

Only Hope

Stock swings are widening, both up and down, even as the S&P 500 has been stuck in a 300-point range during the past two years. In two separate corrections that occurred in August 2015 and earlier this year, the index took round-trip 10 percent swoons and recoveries in the space of no more than 185 days. Back-to-back bull-market swings of that size only occurred once before in the past eight decades -- in 1998.

With valuations likely capped by uncertainty over the U.S presidential election and China’s currency policy, earnings may be the only catalyst that the market can count on to break the grind, according to Chris Hyzy, chief investment officer at Bank of America Corp.’s global wealth investment management division in New York. He said stocks haven’t fully priced in the potential benefit of higher oil and weaker dollar.

“The only thing that can get you excited between now and the end of the year is the potential for earnings surprise,” Hyzy said in an interview on Bloomberg Television. “If you continue to see stability in the dollar and you continue to see oil prices hang in there, you could see another $2 or $3 added to earnings before the end of the year that’s not really factored into the market.”

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