3rd-Quarter Earnings Look to Disappoint — Again – Published in Noozhawk on Monday, October 7, 2013

As we get set to enter the third-quarter earnings season, most are still focusing on the government shutdown and the threat of Federal Reserve tapering, with little interest in corporate revenue or earnings growth. However, the importance of this data will have a lasting impact on the financial markets and the economy, far beyond that of the partial government shutdown.

According to FactSet ResearchStandard & Poor’s 500 earnings are expected to grow 3 percent year-on-year in the third quarter, with the financial sector leading the way and energy firms lagging other sectors. That’s a sizable drop from the beginning of the third quarter, when forecasters projected growth of 6.5 percent. Top-line revenues are expected to grow 2.6 percent for the third quarter, slightly lower than expectations on June 30, when analysts were looking for revenues to increase by 3 percent.

FactSet noted that 90 companies in the S&P 500 had issued negative earnings guidance, which is the largest number since it started tracking guidance data in 2006. Only 19 companies have offered positive guidance, which is the lowest number since FactSet started collecting data. This will be the 10th consecutive quarter of less than 10 percent growth.

The outlook for the fourth quarter remains overly optimistic at 24.8 percent, according to FactSet, so investors should prepare for a heavy round of fourth-quarter profit warnings as well as analyst downgrades and negative adjustments to expectations.

Earnings growth likely hit its low point in the third quarter of 2012 at roughly zero percent year-over-year, so comparisons for this year’s third quarter will look good even if the numbers are not that strong. Comparisons to the second quarter’s results will not look as favorable.

Second-quarter earnings growth of roughly 6 percent was driven by the release of large bank reserves, while nonfinancial companies saw growth of just 1 percent. Top-line revenues expanded by 2.5 percent in the second quarter, compared with basically zero growth in the first quarter. All in all, earnings have been lackluster at best throughout the recovery, and employment growth and GDP accurately reflect these results.

The negative-to-positive pre-announcement ratio for earnings is a widely used metric that compares the number of companies whose earnings guidance falls below Wall Street estimates to the number of firms whose guidance is above analyst consensus. This ratio for S&P 500 stocks stands at 5.1, its fourth-highest reading since 1996, and is only slightly lower than the reading of 6.1 in the second quarter this year.

Bottom-up earnings per share are now expected to rise just 2 percent from a year ago. When this year’s third quarter began, analysts had been calling for nearly triple this amount or almost 6 percent growth. Again, this 2 percent growth estimate is a comparison to the third quarter of 2012, in which earnings growth was essentially zero percent. It is likely that growth will be disappointing, even with the lowered expectations.

With all of the uncertainty surrounding the government shutdown and the possibility of Fed tapering, earnings season has received little attention to date. If earnings were to surprise to the upside overall, this might be a net positive for the stock market. Unfortunately, things appear to be shaping up to be anything but a positive surprise.

The employment report we should have received this past Friday was delayed because of the government shutdown. Although the House of Representatives passed a bill to pay furloughed employees in full for their down time, the shutdown drags on. We are scheduled to receive the September retail sales report and the University of Michigan’s October consumer sentiment survey on Friday. If they are released as scheduled, we should get an early indication of how the shutdown has affected consumer attitudes.

Gross domestic product for the third quarter is on track for growth of just 1.5% percent to 2 percent — matching the pace of the first two quarters of this year. Although we saw growth increase to a 2.5 percent pace in the second quarter, the shutdown and the uncertainty surround Fed tapering will likely place a drag on growth in the fourth quarter, which otherwise might have seen a nice bump with holiday spending. Consumers are unlikely to aggressively spend during this year’s holidays given the multitude of negatives we face.

On a more positive note, if we can get past the shutdown, which will likely only last another few days, and especially if the Fed delays tapering until sometime in early 2014 (likely to happen with the negative impact of the government shutdown on the economy), stocks should have good reason to rally. This will be especially true if we see a significant correction in the near-term, which would set us up for a nice rebound rally into the end of the year.

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