Perfect Earnings Season Record for S&P 500 Is on the Lineby
Stocks off to worst start of year on record amid Chinese chaos
Buying shares over reporting periods returned 11% in 2015
One of the best ways for investors to have made money in U.S. stocks last year was to acquire them just before earnings season began. Bulls need that trade to work now more than any time in the past few years.
With everything from China to the Federal Reserve and oil working against them, investors have had little reason to buy in 2016 -- and the result has been the worst five-day start to any year. Now begins a stretch that lately has been one of the best for stocks, when companies in the Standard & Poor’s 500 Index from Alcoa Inc. to Wells Fargo & Co. begin publishing October-to-December results.
It’s not that earnings are stellar: profits for U.S. companies are forecast by analysts to decline for a third straight quarter, and estimates have fallen steadily since March. It’s that investors trying to assess currency devaluations and equity convulsions 7,000 miles away in Shanghai will at least be reassured that the American economy is holding up.
“What will make people come to their senses is that while economic activity is slow, it’s not headed down,” said Hank Herrmann, chief executive officer who oversees about $100 billion at Waddell & Reed Financial Inc. in Overland Park, Kansas. “One way for that to happen is that in the quarterly commentary management are going to make some upbeat remarks about how they see things forward.”
Friday’s jobs report showed U.S. employers were optimistic about the economy’s prospects just before the recent rout in global financial markets. They added 292,000 workers in December, exceeding the highest estimate in a Bloomberg survey. It wasn’t enough to elevate the S&P 500, which slid 6 percent for the week. The gauge rose 0.4 percent at 9:40 a.m. in New York on Monday.
Goldman Sachs Group Inc. said the carnage of last week, when $1.6 trillion was erased from equity prices, sets up shares for a rebound as results arrive. Traders should buy options on stocks such as LinkedIn Corp., KeyCorp. and Reynolds American Inc., where the potential exists for earnings to exceed Wall Street expectations, derivatives strategists John Marshall and Katherine Fogertey said in a note Friday.
The bull market that restored $14 trillion to U.S. share values between 2009 and now has been driven by earnings, which have more than doubled thanks to expense cuts and zero-percent interest rates. Even when falling, as they have since mid-2015, profits have managed to underpin valuations that exceed levels seen in seven of the last eight bull market peaks and at times prevented losses from snowballing.
“As the economy gathers strength and companies are leaner than they’ve been before, the prospect of greater profits is probably pretty high,’’ said Dan Veru, who helps oversee $3.7 billion as chief investment officer at Fort Lee, New Jersey-based Palisade Capital Management. “It puts some underlying support to the market.’’
Earnings were key to keeping equities from caving after the selloff in August when stocks suffered the first correction since the European sovereign debt crisis in 2011. While the S&P 500 ended down 0.7 percent for 2015, a strategy of buying shares during the peaks of four earnings season would have returned about 11 percent, according to data compiled by New York-based FBN Securities Inc.
One of the reasons stocks have done well is the propensity of companies to beat analyst predictions when they report results. The S&P 500 climbed an average 2.3 percent over the month following Alcoa’s announcements in 2015. That’s about four times the normal rate of return for all reporting seasons in data going back to 1993.
Companies posted quarterly results that exceeded Wall Street projections by an average of 4.1 percentage points in 2015. Should they match that rate again, earnings for the full index would shrink 2.6 percent in the fourth quarter, rather than the 6.7 percent estimated by analysts.
“The earnings theme generally has been pretty well accepted,” said JC O’Hara, who watches price charts to predict moves in securities at FBN as chief market technician. “When news coming out of companies and conference calls were much more upbeat and positive, stocks just cued on that. If the market starts to key in on earnings and we do get some decent outlook, that will take the focus off the rest of the world.”
There are signs investors are skeptical this will keep happening. Stocks just posted the worst one-month decline prior to an earnings season since 2009 as China’s currency devaluation renewed concern over a global slowdown and the Federal Reserve raised interest rates for the first time almost a decade.
Expanding profit margins when sales are sagging can only last so long, and without a stabilization in the currency and commodity markets, the earnings picture will remain cloudy, according to David Lafferty, the Boston-based chief market strategist for Natixis Global Asset Management, which manages $966 billion.
“Not only are earnings going to be hard to come by, but given the geopolitical risk, the slowdown in China and the strength we have in the dollar, those earnings headwinds are going to make making guidance very murky,” Lafferty said by phone. “The big macro and geopolitical events are swamping earnings right now.”
While oil’s 70 percent plunge may pull overall income down, companies in the S&P 500 earn far more today than they did at the height of the last two bull markets. Profits in the index are expected to approach $1 trillion in the 12 months through December, compared with $740 billion in 2007 and $490 billion in 2000, data compiled by Bloomberg show. Analysts forecast a rebound for all of 2016, with profit jumping 6.8 percent.
At 21 times reported income, the S&P 500 traded 24 percent higher than its average since 1936. With valuations elevated, further share gains will depend on profit growth, according to Ernesto Ramos, head of equities who helps oversee $249 billion at BMO Global Asset Management in Chicago.
“Without earnings, the market is going nowhere,” Ramos said. “As they start to come in, maybe less negative that people are anticipating, that will allow the market to recover.”