Since the start of the fourth quarter earnings reporting season, investors have been heavily punishing companies that gave weak outlooks for this year—even those that smashed estimates for the fourth quarter. As the first two months of the year rolled on, Wall Street cut its earnings estimates further and further, and one firm is seeing a pattern that’s similar to what was observed in 2009.
This is particularly interesting because the third quarter brought the first year over year earnings decline for the S&P 500 since 2009. That year was also the last time we saw back-to-back quarterly earnings declines—just as we have with the third and fourth quarters of 2015.
Earnings estimate revision ratio still falling
Bank of America Merrill Lynch strategist Savita Subramanian noted Wall Street’s extreme pessimism regarding earnings in a report dated March 2. She reports that the three-month earnings estimate revision ratio declined for the sixth month in a row last month, edging lower from 0.49 to 0.47.
That’s the lowest level the metric has been at since April 2009, and she said it suggests that we’re seeing twice the number of estimate cuts compared to increases over the last three months. She added that the long-term average is 0.84, which puts this latest reading far below that and suggests that the S&P 500 will see only muted returns.
On a one-month basis, the earnings estimate revision ratio improves significantly from 0.35 to 0.54, which is similar to what she observed from October to December.
Health Care earnings cuts on the rise
Subramanian said analysts kept cutting their estimates in the Energy sector, although the cuts among Industrials slowed down as the sector’s three-month earnings estimate revision ratio climbed for the second consecutive month since bottoming out in December. The ratio for the Materials sector improved as well, although she added that it is still low.
The one sector that saw the biggest deterioration in earnings estimates was Health Care, as she reports that it has fallen in each of the last five months after hitting its highest level in four years in September. Now the sector’s estimate revision ratio sits at 0.62 after peaking at 2.22 last year.
Tech and Utilities have also seen their revision trends worsen over the last four to five months, although not as much as Health Care. The Financials sector recorded the biggest drop in February as interest rates declined further and concerns about growth, credit and oil prices continue to swirl.
Wall Street especially bearish on sales
According to the BAML strategist, Wall Street is cutting sales estimates even more than earnings estimates as the three-month estimate revision ratio for sales fell from 0.41 to 0.38 in February. The ratio had remained steady in the previous three months. She adds that just like with earnings, this was the highest level of pessimism among Wall Street analysts since April 2009.
The one-month ratio, which is more volatile than the three-month, improved slightly from 0.32 to 0.39. The worst sales revision trends continue to be in sectors with high exposure to commodities.
Earnings Estimates – Guidance weak but normal
Interestingly, Subramanian said that while S&P 500 companies have been issuing weak guidance, there’s nothing out of the ordinary about it. Meanwhile investors have been seriously penalizing companies that issue weak guidance, which suggests that the general consensus view is that guidance should be better this time of the year, even though it typically isn’t.
In fact, Subramanian said the three-month management guidance ratio edged higher from 0.49 to 0.51 last month after a decline in January which brought it under the long-term average of 0.62. She said this suggests that we have been seeing double the number of instances of guidance that’s below consensus than we are that’s higher than consensus over the last three months.
On a one-month basis, she said the ratio rose to 0.58 where it was in November and December from January’s 0.49.
Earnings Estimates – Pessimism might end soon
Looking at individual sectors, she said all of them are seeing more guides that are lower than consensus than above. However, she added that the ratio is in line with what is usually observed in January and February, which usually are seasonally weak months for both earnings revisions and guidance.
She also believes that the pessimism from both analysts and company managements might lessen in the next few months thanks to seasonality grouped with improvements in economic data and rising oil prices.