Breakout

Q2 Earnings: Low Expectations, High Hopes

Breakout

Imagine running in a race that got shorter — or easier — the closer you got to the finish line. And not just a little bit easier, but a lot easier. Like 83% easier.

As strange as that seems, something similar is happening on Wall Street right now, as increasingly worried analysts have cut their earnings growth expectations for the S&P 500 (^GSPC) by a stunning 83%.

As FactSet earnings analyst John Butters explains in the attached video, the expectations for profits has been lowered to just 0.7%, down from 4.2% on April 1.

"If we finish at 1%, it would be the third weakest earnings growth we've seen in the last four years," Butters says, pointing out that sales expectations have also come down by 62%. "On the revenue side, we were looking for about 2.7% [sales growth] at the start of the quarter — and that's down to 1% today."

Related: Is Alcoa the Earnings Season Bellwether?

It's no wonder three-quarters of companies reporting are able to "beat the street." But as was the case with Alcoa Monday night, it takes more than better-than-expected results to move a stock. In fact, if it weren't for the increasing expectations surrounding the Financial sector (XLF), Butters says the growth rate would have actually slipped to -2.5%.

"One of the reasons we saw the numbers come down so much is because we saw a record amount of negative guidance," he explains. So far, 87 of 108 companies [or 81%] that have offered an outlook have done so below the existing consensus estimate, led by near-unanimous backtracking in the forecasts of companies in the Materials (XLB), Industrials (XLI) and Technology (XLK) sectors.

The point is, impressing Wall Street should not be difficult to do this quarter, which partially explains why stocks are edging back toward all-time highs. In fact, Butters says stocks are still cheap compared to their ten-year average and now trade at just 13.9 times forward estimated earnings. But here's the catch: second-half growth expectations have not come down much and are still baking in solid growth of 7% and 13% for the third and fourth quarters, respectively.

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