Have Earnings Estimates Come Down Enough?

Corporations begin reporting fiscal fourth-quarter results in earnest next week and provide updated guidance for the coming year. Analysts have been tripping over themselves over the past few months, reducing 2019 expectations.  However, have expectations been sufficient lowered or will we experience even lowers lows?

Earnings for the S&P 500 reflect the fourth quarter of 2018 is expected to still show 12%-14% year-over-year growth but expectations for first few quarters of 2019 have been ratcheted rapidly lower over the past few months — with the latest set of data placing consensus for around 2%-5% through the first half of the year.

The progression of reducing estimates this early in the year stands in sharp contrast to the historical pattern, which usually starts with optimism and slowly gets reduced over the course of the year as reality sets in.

But with a host of companies issuing warnings, analysts have been forced to revise their numbers and investors have been selling first rather than waiting for the results.

Certain sectors have already seen share prices decline over the prior few months, such as oil and semiconductors which is due to sub-$50 oil and weak chip demand.

But the first real company-specific warning shot came from FedEx (FDX) in mid-December when the shipper slashed its 2019 revenue guidance, citing worldwide slow down with special emphasis on China. FDX’s stock dropped over 15% over the next few days.

The next big salvo came from Apple (AAPL) on the first day of trading when it lowered expected iPhone sales with China once again being a locus of blame.  AAPL shares are now 33% below the October high.

Now, over the past few days — in quick succession — we’ve had airlines like Delta (DAL) and American (AAL) issue warnings and see their shares sink to new lows.

Warnings from retailers like Macy’s (M) and Gap (GPS) have also cast doubt over just how strong holiday sales were and the state of consumer spending.  

The silver lining to all these warnings is that the stock market tends to be a discounting mechanism; meaning some pretty bad news is now already priced into current share and valuation levels.

Indeed last earnings season, which was pretty strong across the board, was met with mostly negative reactions.  According to data compiled by Bank of America, companies that beat estimates outpaced the market by less than one percentage point in first-day reactions.

In fact, many stocks, especially tech names that had racked up big gains during the first half of 2018, sold off hard despite posting good numbers.  The punishment for falling short was more than twice as big with the stocks dropping an average of 7%, following an earnings miss.

So, with expectations now as low has they’ve been in over 3 years could we be setting up for a buy the news scenario?

Sundial Research looked at past instances when analyst sentiment deteriorated and found that such outbursts of bearishness actually boded well for equities.

Since Bloomberg began tracking the data in 2010, the spread between price-target upgrades and downgrades dipped below 150 five times. On all but one occasion, the S&P 500 rose two months later, posting a 6 percent median return.

Many companies should have no problem clearing the lowered hurdles and transforming the narrative from negative to positive.

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