The S&P 500 has taken a beating this year as investors flea companies that have issued weak guidance with their fourth quarter earnings reports, and it doesn’t look like things are going to let up any time soon. We saw a bit of relief last week on Monday, but as the retail earnings reports begin coming in, investors are beginning to worry again. Wal-Mart, Target, Lowe’s and others have spooked investors despite their strong fourth quarter results.
Earnings winners not rewarded, losers severely punished
Morgan Stanley analyst Adam Parker and his team said this week in their report titled “Is the Windshield Different than the Rear-view Mirror” that the fourth quarter earnings season demonstrated a continued trend of strength from last year. However, the third quarter brought the first earnings decline for the S&P 500 since 2009.
We’re closing in on the end of the fourth quarter reporting period with more than 90% of the index having reported, and Wall Street estimates are finally beginning to improve, although the decline is much worse than it was in the third quarter. According to S&P Capital IQ, analysts are now predicting a 4.55% decline in earnings for the index. That’s a significant improvement from the 5.2% decline projected at the beginning of the reporting period and the peak on Jan. 27 at 6.3%
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The good news though is that we’re seeing a trend of upside from expectations with the earnings beat rate at 65%, although that’s slightly behind the historic average of 66%, according to S&P Capital IQ Senior Analyst Lindsey Bell’s Wednesday earnings update. Here’s a look at the beat rate by sector, according to Bell’s data:
Most earnings upside in Materials
The Morgan Stanley team said the Materials, Consumer Discretionary and Technology sectors have brought the most upside to estimates.
Meanwhile revenues are coming in a bit below consensus estimates although interestingly, Energy is leading the way with the most contributions, followed by Financials and Consumer Discretionary.
A huge trend we’re seeing with fourth quarter earnings is that companies which beat estimates are seeing only small rewards, if any, while companies that miss are being severely punished.
The Morgan Stanley team added that the trend of “modestly” rewarding beats and “harshly” punishing misses is a reversal from the third quarter reporting period when they saw “equal reward for beating relative to the penalty for missing.”
Negative guidance greatly outweighs positive
Companies that issued weak guidance are being punished even more, and, in many cases, companies that beat in the fourth quarter but issued weak guidance are being punished just as badly or sometimes even worse than those that just missed fourth quarter estimates.
As a result, what’s even more troubling is that the Morgan Stanley team found significantly more instances of negative guidance than positive. In fact, there are more than four negative guides (4.44 ratio) for every one positive guide (when comparing to consensus estimates).
They add that this rate is much more negative than what’s been observed since the fourth quarter of 2013 and far above the recent yearly average. While this is generally taken as a negative because it suggests that trends are slowing down, they see a positive in that the bar for earnings is being set very low for this year.
They found a 2% downward revision in full-year earnings estimates for the S&P 500 over the past month, with Energy being the biggest driver by far with a 35.5% decline.
Mixed rather than negative trends
Further, they don’t think the overall trends are as negative as most investors believe. They do say that Wal-Mart’s earnings comments were clearly negative for consumers, but generally they think the data points have been mixed. For example, they found a long list of areas in which they said macro trends are “reasonable”: auto credit; new car prices; SUV demand; data center footprints; utility power demand; Dow Chemical’s commentary on plastics demand from consumers; most cash dining chains; CVS; Visa; credit card master trust data; and ad spending.
“There are many more, but in aggregate we think the EPS season has been mixed, not negative, and the market is certainly discounting a higher probability that data points markedly deteriorate than we think is likely,” Parker and team concluded.