Wall Street Misses Expectations for U.S. Economy
Although the focus of traders’ attention is currently split between the goings on in the Eurozone and the expectations for Ben Bernanke’s cavalry to ride to the rescue tomorrow, a glance at the calendar reveals that the quarterly earnings parade is scheduled to start rolling again in a little over three weeks. So, while we are waiting on the results of “the call” (Greece’s two-day feel-good session with the EU/ECB/IMF – aka the “Troika”), we thought we’d turn our attention from the macro outlook to micro.
Perhaps the biggest “miss” of the year so far has been Wall Street’s expectations for the U.S. economy. If you will recall, just about every bank on the street was looking for robust gains in the stock market in 2011 to be driven largely by an improving economy and EPS on the S&P 500 of somewhere in the range of $100. Given that this level would be a new all-time high for EPS of the 500 stocks in the index, it wasn’t hard to argue with the view that this was the year to be invested in the U.S. stock market.
Given that EPS (earnings per share) is viewed by most investors to be the mother’s milk of stock prices, we thought it might be a good idea to check in with the earnings expectations before the upcoming reporting season gets started.
Unfortunately, there is no clear consensus on Q3 earnings expectations at this time. Coming into the last two reporting seasons, the bulls could basically count on the fact that earnings were going to be substantially higher than the estimates. And with three straight quarters of 20%+ increases in year-over-year EPS, it is easy to see why stocks had enjoyed an upwards bias. However, that streak appears to now be in jeopardy.
At the beginning of July, Bespoke Investment Group reports that the consensus expectations for the coming quarter’s earnings on the S&P 500 were good, but not quite at the 20% level. As of July 1, analysts had been looking for an increase of 17.5% on the S&P’s EPS. However, given the Summer of Discontent II that developed, those estimates have been falling. On August 5, the estimated percentage gain for S&P earnings had fallen to 16.5%. On September 1, the expected gains were down to 14.9%. And this week they stand at 13.7%.
The bottom line here is with analysts having dropped their EPS growth estimates by more than 21% in just two months, Bespoke questions whether earnings estimates have fallen too far. And since the game is normally about reality vs. expectations, this could be a good thing.
On the other side of the argument is the idea that both the second half and full-year 2011 EPS estimates are still too high, which would seem to set up the possibility for disappointment. Ned Davis Research was out with a report yesterday stating that while estimates for Q3 EPS have clearly come down over the past month, earnings growth of any kind is a difficult task when the economy is in recession.
To be clear, no one is saying that the U.S. is currently in recession. However, given the anemic GDP growth seen this year (0.36% in Q1 and 0.98% in Q2) and that almost every economist on the planet has at least admitted that the risks of a recession have increased substantially; it is worth looking at how EPS of the S&P fares during a recession. In short, the numbers aren’t pretty.
While not a surprising stat, it is worth noting that on average, GAAP earnings tend to fall during a recession. History shows that of the 15 recessions since 1926, EPS for the S&P has only been positive 5 times. The rest of the time, earnings actually decline. For example, during the 2001 recession, EPS on the S&P fell more than -37% and in the 2008-09 debacle, EPS plunged -88%.
The point this morning is that while the U.S. does not appear to be in recession at the present time, it is worth remembering that analyst estimates on EPS tend to be off the majority of the time and way off when the economy slows. So, we will need to continue to watch the economic indicators closely going forward.
Turning to this morning… Stock futures initially declined on the report that Italy’s debt rating had been downgraded by S&P. However, hope is the watchword of the day as expectations are for (a) everything to be declared peachy keen after “the call” in Greece and (b) the Fed to save the day (again) tomorrow. As such, futures are now pointing a higher open as traders apparently view any and all dips as a buying opportunity.
On the Economic front… Housing Starts fell in August to an annualized rate of 571K. This was below the consensus for 588K. The July numbers were revised lower to an annualized rate of 601K from 604K. Building Permits for July rose to a rate of 620K. This was above the consensus of 588K and last month’s reading of 601K.
David Moenning
Editor: The Daily Decision
