Earnings Expectations Could Be Set Too High For 2017

Earnings Expectations Could Be Set Too High For 2017

Fourth quarter earnings season kicks off this week unofficially with a batch of bank reports on Friday (not Alcoa, which usually is the case, as the aluminum maker is expected to report later in the month). Among the reports we’re expecting this week are Bank of America, Wells Fargo and JPMorgan Chase. But earnings expectations for the S&P 500 could be too high, which could spell trouble for the index and its constituents as investors look to the upcoming report to push the market higher.

Earnings Expectations – S&P 500 on the rise

Last week marked the first week of trading for 2017 and the S&P 500 continued its steady march upward—until this week, that is. The index opened lower on Monday as investors pondered the possibility that total earnings for the S&P 500 could come up short of expectations.

S&P Capital IQ Investment Strategist Lindsey Bell warned in her Jan. 5 preview of the Q4 reporting period that consensus estimates might be too high. Currently the consensus earnings per share estimate for the S&P 500 stands at $30.58, which would be a 4.4% year over year increase in earnings. It would also mark the second consecutive increase after four falling quarters starting in the third quarter of 2015.

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Earnings estimates “reasonable,” but…

Despite her reservations, Bell calls the consensus estimate “reasonable,” as earnings per share for the index rose 4% year over year in the third quarter. She also noted that data on the economy improved, and we’ve seen fewer negative preannouncements compared to previous quarters. Further, this time the fourth quarter is up against an easy comparison, as the fourth quarter of 2015 recorded a 4.1% decline in earnings per share.

So Bell’s concern isn’t so much with the consensus, but rather, what investors could be pricing in. She thinks they’re looking for earnings to come out better than expected. While it’s true that the S&P 500 usually beats the beginning consensus by 300 to 400 basis points, she’s concerned that investors could be looking for a beat greater than that.

Earnings Expectations – Concerns about guidance

She noted that growth in earnings per share hasn’t come up short of expectation since the first quarter of 2009, and the beat rates for the two previous quarters were 4.9% and 3.5%. As a result, as long as investors don’t look for a beat greater than 300 to 400 basis points, Bell doesn’t expect the fourth quarter reporting season to “rock the market.”

However, one area for concern will be guidance, as she suggests that companies might cut guidance below the current estimate. Although this is standard practice, she thinks it could cause the market to pause or pull back. She categorizes this as a near term market risk, as estimates could rise throughout the year.

“We think it will be a tall order for corporate management teams, who have been quite conservative in recent years when providing guidance for the new year, to raise guidance at this point in time, i.e. before Trump’s policies become reality,” she wrote. “Currently, the consensus estimate is for growth of 11.7% in 2017.”

Uncertainty with Trump

Bell adds that the S&P 500 has popped 6.1% since the election, but that’s much more than the typical increase of 2.3% after an incumbent president or party was replaced.

Two main reasons she gives for her expectation of lower guidance are the rising dollar and higher oil prices. Also the election of Republican Donald Trump to the nation’s top post has created a great deal of uncertainty for the economy and the markets. Bell expects the near term to be marked by volatility until investors begin to see exactly what will happen under Trump because he is widely seen as unpredictable.

Earnings Expectations –

Energy sector to stop being such a drag

Bell expects the greatest improvement in earnings growth this year to be a dramatic reduction in drag from the Energy sector. Consensus currently stands at a 9.4% decline for Energy, compared to the 67.5% decline in the third quarter and 86.1% decline in the second quarter. The other sectors with earnings growth expected to be in the red are Real Estate, Industrials and Telecommunication Services.

Earnings Expectations
Earnings Expectations

Financials, Utilities, Information Technology and Materials led the way in the third quarter and are expected to do so again in the fourth. If consensus is accurate, the fourth quarter will be the second consecutive quarter in which Financials post growth in the double digits. The projected 4.4% growth rate in earnings for the S&P 500 is the best growth in quite a awhile, although Bell noted that it still lags the average 8% quarterly growth from before the earnings recession.

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