May 14, 2012
The seemingly never-ending stream of corporate earnings is about to draw to a close – at least for six weeks or so, until the second quarter ends June 30, and it all begins again. With a cluster of retailing companies about to release their own results this week, by Friday all but a handful of the companies in the S&P 500 index will have given investors an accounting of what happened during the first quarter and a glimpse into their outlook for the second quarter of 2012, now under way. And now those investors will have to ride out six weeks or so with little reassurance in the shape of solid corporate news to weigh against panicky headlines about trading losses at giant banks or the prospect of financial Armageddon in the Eurozone.
Indeed, the first quarter results were surprisingly positive. Even as the stock market rallied throughout the first three months of the year, analysts covering individual stocks progressively cut back their earnings estimates for companies in the S&P 500. Last summer, they predicted that first-quarter earnings would be 12.8 percent higher; by early January, that figure had been pared to about 6 percent. By the end of March, however, that estimate had been cut in half again, according to data compiled by Greg Harrison, an analyst who tracks earnings trends for Thomson Reuters’ proprietary research division. By the end of March, however, they were calling for only 2 percent growth for S&P 500 earnings.
The reality? Earnings currently are running 8.3 percent higher than they did a year ago, and Harrison says they look likely to finish the quarter about 7.9 percent higher than they were in the first quarter of 2011. Admittedly, that is less than half the rate of growth reported for the year-ago quarter, when earnings grew 18.1 percent, but relative to the winter pessimism, it’s an impressive result. Moreover, even though the rate of positive earnings surprises hasn’t been as high as it looked initially – 80 percent of early-reporting companies generated higher-than-expected results – a still impressive 66 percent did better than analysts predicted while only 24 percent fell short.
Now we move on into limbo, and a period of tremendous uncertainty for the stock market. The fact that earnings news has generally been better than expected has helped offset periods of weakness throughout April and into May. But in a tug of war between reasonably upbeat fundamentals – in the shape of solid if unspectacular gains in corporate profits – and growing anxiety on a macro level, what happens when one side stops tugging on that rope? Logic dictates that anxiety takes over, as investors resume fretting about events in Europe and the prospect that Chinese growth is decelerating to a greater extent than previously believed.
It’s all part of the same pattern – for every step forward, the market and the economy take at least 0.9 of a step backward.
The unemployment rate declines? Fine, but the rate at which the unemployed are simply leaving the job market altogether is rising, warning us that the “real” unemployment rate could be far higher, while the percentage of those under the age of 25 who are jobless remains high.
Corporate earnings rise in the first quarter by nearly as much as they did in the fourth quarter of 2011? Fine, but those two quarters are the only ones since corporate profits began to recover in late 2009 that the rates of growth haven’t broken into the double digits – and the trend is lower.
The real question surrounds what will happen when these two trends – the fundamentals and the macro backdrop – converge. If the outlook for Europe remains bleak and Chinese growth isn’t strong enough to pick up any slack, the global economy will slow. And that means trouble for U.S. companies and for consumers. We are an integral part of that global economy, relying on consumers around the world to buy our goods and services. Few U.S. companies can shut themselves off from the global economy, and few U.S. consumers – who earn their salaries by working for those businesses – can isolate themselves from the fallout of, say, an economic disaster in Europe.
The headlines in Europe are becoming more dire at a perilous point in the calendar, as we enter a five- or six-week time period in which companies won’t be providing us with a steady stream of reassuring news in the shape of solid profits, dividend increases or upbeat forecasts. Not until the last week or so of June – the earnings preseason – can we expect that flow of fundamental news to resume and to offset the psychological impact on the market of European debates over austerity or the possible departure of Greece from the Eurozone.
The financial world, in an attempt to make it seem more humorous than it actually is, has taken to referring to this as “Grexit," and the attitude has become fatalistic. “They might as well get it over with,” one trader told me, resignedly, last week. The problem is that if they do, we can look for a repeat of last summer’s stock market declines -- and we should brace for the prospect that even robust gains in profits for the second quarter won’t be enough to compensate.