Photographer: Scott Eells/Bloomberg

Goldman Sachs Has a Warning For This Quarter's Corporate Earnings

Fewer upside surprises in the cards.

When Goldman Sachs Group Inc. Chief U.S. Equity Strategist David Kostin puts on his macro goggles, he sees a disappointing third-quarter earnings season ahead.

"Variables that determine earnings surprises – changes in U.S. economic growth, interest rates, oil price, the dollar, and EPS [earnings per share] revisions – suggest a below-average share of firms will report positive earnings per share surprises (43 percent vs. 46 percent)," he writes in a note to clients. " We see a weak third-quarter reporting season coupled with negative fourth-quarter EPS revisions pushing stocks 2 percent lower to our year-end target of 2,100."

Q3 KOSTIN
Source: Goldman Sachs

The third-quarter earnings season unofficially kicks off on Tuesday when former Dow component Alcoa Inc. reports.

The sole silver lining on the macro front is the year-over-year decline in crude prices — but it's also what will cause the energy sector to be the largest drag on the S&P 500's adjusted earnings per share, Kostin argues. Bottom-up forecasts indicate that at the aggregate level, adjusted EPS will decline by 1 percent year-over-year, he says.

Goldman's proprietary measure of U.S. economic activity suggests the third quarter's expansion is sluggish relative to the same period in 2015, while the drop-off in 10-year Treasury yields since that time will weigh on the earnings of banks and other financials.

Analysts have recently taken a dimmer view on the upcoming earnings season, but that pessimism has yet to trickle into their official expectations for Corporate America's performance in the final three months of the year, Kostin adds.

As the impact of the macro tide turning against stocks becomes clearer through the earnings season, Goldman sees sector leadership returning to defensive, yield-oriented stocks and away from cyclicals.

XLU US Equity (Utilities Select  2016-10-10 08-55-28
Source: Bloomberg

"A poor earnings season could pressure stocks, sending the market index lower and pushing investors back toward defensives," concludes Kostin. "Additional negative EPS revisions and rising uncertainty in advance of the presidential election add to the case for defensive firms."

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