Something doesn't look right.
There's been an awful lot of belly-aching about the Federal Reserve possibly beginning to taper, or gradually reduce, its stimulative bond-buying program.
Some have attributed the risk of the taper to the return of volatility in the stock markets.
But this volatility may be explained more directly by a larger, more theoretically sound reason: deteriorating earnings expectations.
"[E]arnings matter the most for equities, in our opinion, and there is relatively robust statistical evidence to back up that contention," said Citi's Tobias Levkovich in a note to clients last week.
"In this respect, we have been a tad shocked by the surge in negative-to-positive preannouncement trends that make 2009’s surge appear less worrisome in retrospect. Upward earnings guidance has dipped as well and there has been little consternation or discussion about it."
FactSet's John Butters examined this trend closely recently with regard to the quarter that just ended.
"For Q2 2013, 87 companies have issued negative EPS guidance and 21 companies have issued positive EPS guidance," said Butters. "If 87 is the final number, it will mark the highest number of companies issuing negative EPS guidance for a quarter.
"The percentage of companies issuing negative EPS guidance is 81% (87 out of 108)," Butters added. "If this is the final percentage for the quarter, it will mark the highest percentage of companies issuing negative EPS guidance for a quarter."
The weirdest thing about this is that this trend has been getting worse for years and the stock market has only been going up.
"Although the number of negative preannouncements is running at an all-time high, the market is not punishing the performance of these stocks in the short term," said Butters. "For the 87 companies that have issued negative EPS guidance for Q2 2013 to date, the average price change (2 days before the guidance was issued through 2 days after the guidance was issued) was +0.1%. This percentage is well above the average of -1.2% over the past five years."
Here's a chart FactSet demonstrating this counterintuitive yet troubling trend:
It remains to be seen whether or not the stock market will crack under this trend.
But for now, we can try to make sense of the fundamentals.
Butters notes that revenue guidance has been deteriorating, which could reflect problems with demand.
"For Q2 2013, 55 companies have issued negative revenue guidance for the quarter and 14 have issued positive revenue guidance," said Butters. "As a result, 80% (55 out 69) of the companies that have issued revenue guidance for the quarter have issued negative guidance. If this is the final percentage for the quarter, it will mark the third highest percentage since 2006."
Based on corporate commentary, much of this is due to problems overseas, specifically in Western Europe and the big emerging markets. Here's a roundup of some quotes from the big multinationals via FactSet:
“The economy in Europe continues to be a challenge and China appears to be slowing down as well.” –HP (May 22)
“For the quarter, Europe's results were dampened by ongoing economic uncertainty. First quarter comparable sales were down 1.1%...” –McDonald’s Corp. (Apr. 19)
“We planned for Europe to be similar to 2012, down again, but it was even weaker than we had expected.” –General Electric (Apr. 19)
“In Asia/Pacific, Middle East and Africa (APMEA), first quarter comparable sales declined 3.3% primarily due to ongoing weakness in Japan and negative results in China.” –McDonald’s Corp. (Apr. 19)
“But our growth markets revenue was up 1% at constant currency, clearly not what we expected or what we needed.” –IBM (Apr. 18)
“As we look ahead to the remainder of 2013, we continue to expect China's economic slowdown to have a short-term effect on our industry and on our business, although we do expect to see some gradual improvement in consumer disposable income and, as a result, sequential improvement for our business as the year progresses.” –Coca-Cola (Apr. 16)
“Yeah, so in China, I think the market is very, very strong... I think property transactions in the first quarter were up 60% in China. So again, the market's a lot better than what we had anticipated. We saw that starting in the fourth quarter.” –United Technologies (Apr. 23)
“China results continued very strong, with total sales growing 40% and comparable store sales rising at a double-digit rate.” –Coach (Apr. 23)
“Most of our emerging markets, including China, remained strong.” –General Electric (Apr. 19)
Q2 earnings season starts in a few weeks. It'll be interesting to hear what companies say and how the markets react.
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