What to Expect From the Third Quarter Earnings Season
Largely overshadowed by the ongoing drama in Washington (more on that below) is the third quarter earnings season, which begins in earnest this week.
But precisely when it begins depends on whom you ask.
Traditionally, aluminum giant Alcoa (NYSE: AA), which reports tonight, has held the lead spot in the quarterly parade, because it’s the first Dow component to report. Many investors also look to Alcoa as a bellwether for stocks and the wider global economy. But there is an ongoing debate about whether that’s still true, given the company’s market cap, which has fallen to just $8.5 billion, and an ongoing oversupply of aluminum, which has weakened prices.
To add insult to injury, Alcoa was recently booted from the Dow Jones Industrial Average, along with Bank of America (NYSE: BAC) and Hewlett-Packard (NYSE: HPQ), officially ending its days as the first Dow component out of the gate.
As a result, some investors are looking to Nike (NYSE: NKE) as the new lead-off hitter, because it’s now the first Dow component to release its results. But the athletic gear maker isn’t the best fit, either, as it reported on September 26, before the quarter officially ended, and its fiscal year winds up on May 31.
The first Dow component on a calendar year to report is J.P. Morgan Chase (NYSE: JPM), on Friday.
Lowering the Bar
No matter where you place the starting line, one thing is certain: expectations for corporate earnings in the recently concluded quarter have fallen—but as usual with Wall Street, there’s more to that than meets the eye.
According to FactSet, 90 S&P 500 companies have lowered their earnings outlooks for the third quarter, the highest number since FactSet started keeping track in 2006. Meanwhile, just 19 had increased their guidance—a new low. However, it’s important to note that the previous record was held by the second quarter of 2013 (88) and before that, the first quarter of this year (86), according to the Wall Street Journal.
“I think companies have done exactly what they do in the confessional month every cycle. They try to talk the numbers down so they can engineer an upside surprise,” said Phil Orlando, chief equity market strategist at Federated Investors, in a September 30 Reuters article.
Analysts, too, have cut their expectations, with overall earnings growth for S&P 500 companies forecast at 4.6% for the third quarter, according to Thomson Reuters data, down from 8.5% at its beginning.
All this stands in sharp contrast to stock prices. Over the past year, the S&P 500 has gained about 15%, prompting some analysts to ask whether stocks are entering overvalued territory. FactSet’s numbers give some credence to this view, stating that the S&P 500’s 12-month forward p/e ratio stood at 14.2 as of October 4, above the five-year (12.9) and 10-year (14.0) averages.
But that opinion is far from unanimous, with Warren Buffett among the dissenters. “[Stocks] are probably more or less fairly priced now,” he recently told CNBC. “We don’t find bargains around, but we don’t think things are way overvalued, either.”
Financials Lead, Energy Lags
In all, FactSet expects eight of the 10 sectors in the S&P 500 to report higher earnings than a year ago, propelling the entire index to a 3.0% rise in the quarter. Financials are set to lead for the third straight quarter, with a forecast 9.1% growth rate, while energy will bring up the rear, with a year-over-year decline of 2.2%. Health care is also expected to finish in negative territory, with a 1.4% drop.
The financial gains all come down to two companies, according to FactSet: Bank of America and Morgan Stanley (NYSE: MS), which are up against weak comparisons from a year ago. Set those two aside, and you’re looking at a 0.6% earnings contraction for the sector.
At the other end of the spectrum, two subsectors play a big part in energy’s weakness: coal and consumable fuels, and oil and gas refining and marketing, which FactSet sees posting year-over-year declines of 93% and 59%, respectively.
Beyond Third Quarter Earnings
As always, our Investing Daily editors are keeping a vigilant watch over the global economic landscape as we move into the fourth quarter. Here are two fast-developing stories that Philip Springer, chief investment strategist of our Personal Finance newsletter, is keeping close tabs on:
- Shuttered government: buying opportunity or disaster in the making? Investors have reason to be wary heading into October, wrote Springer in an October 4 article, particularly in light of the government shutdown and the threat of default if the nation fails to increase its debt ceiling.
“Now October looms, with one significant threat: our politicians in Washington, D.C.,” Springer wrote. “Moreover, October historically has been a month of some dramatic declines, notably the crashes of 1929 and 1987, plus the 17% drop of 2008.”
“But here’s another perspective,” he continued. “Since 2010, the bull market has been interrupted six times. Three of its significant pullbacks have been related to the European financial crisis. The other three came because of the political dysfunction in Washington.
In the spring of 2010, it was the fight over passage of the Affordable Care Act. In the summer of 2011, it was the histrionics over lifting the debt ceiling and the first-ever credit downgrade of U.S. government debt. Late last year, it was the uncertainty over the presidential election and then the battle over the so-called fiscal cliff.
If history is a guide, we might see a significant market pullback amid the latest Washington crisis. But the historical precedent also points to an excellent buying opportunity if that occurs. In any event, these troubles will pass.”
- Europe: Getting up off the mat? In a September 27 article, Springer examined the rising tide of positive economic data from Europe, including a forecast return to growth for 2014—though very modest, at an expected 0.8% rise in euro zone GDP—as well as improvements in economic sentiment and a slowing rise in the unemployment rate.
“This very gradual economic improvement would still be inadequate to reduce the euro zone’s main problems, led by a record-high unemployment rate of 12.1%, hefty government debt and uncompetitive labor costs, benefits and taxes,” he wrote.
“What’s more, many uncertainties remain about even the sluggish growth that’s expected. For instance, new data from the ECB showed that bank lending to companies fell in all of the euro zone’s big countries in August.”
Still, Springer sees reasons for cautious optimism on the debt-wracked continent. “Europe is improving. Its blue chip stocks generally are attractively priced and pay good income. But the road ahead will be long and bumpy,” he wrote.