Sweet (Earnings Expectations) Dreams Are Made Of This

Tyler Durden's picture

ConvergEx's monthly review of analysts' revenue expectations for the 30 companies in the Dow finds a ray of sunshine (let's call them 'sweet dreams') to counter the current humdrum market action. First, the 'good' news: analysts expect the current quarter to post some of the best top line growth in over 2 years. The 'meh' news: that’s still only a 2.5% comp to last year, and 2.9% excluding financials.  Still, that is better than the 0.3-0.5% growth of Q1 2014.  That acceleration, such as it is, continues into Q3 2014, where analysts have revenue growth pegged at 3.9%.  The 'bad' news: brokerage analysts have been spectacularly wrong in forecasting revenues of late. In Q1 2014 the Street expected 4-5% growth in May of last year, only to whittle those numbers down month after month and still prove too optimistic on earnings day. Still, things might work out this time and Q2 will actually see a rebound. At current valuation levels, the bulls better hope they do.

Via ConvergEx's Nick Colas,

There is an old joke on Wall Street: “What’s the difference between a bond and a bond trader?”  The answer: “Bonds mature.”  Yes, the fixed income group in a given brokerage firm or money manager may house more bon vivants than Soho House during NY Fashion Week, but scratch a bond guy/gal and you’ll quickly find the pessimist lurking within. That’s because this group knows that over the long run the best they can do is get their money back from a bond, plus interest.  Their upside is the issuer just keeps their promise.  Your downside is they don’t.  The chance for a surprise windfall is zero.

The real optimists of Wall Street sit on the equity desk.  They may play the bear from time to time, just to show they can.  But stock investing is ultimately about how things can go right in pleasant and unexpected ways.  The core argument for owning equities always ends with “And they lived happily ever after.”  Even the turmoil of the last 20 years hasn’t shifted that foundation.  Over the very long term, equities beat other asset classes because you are long human innovation when you own a portfolio of stocks.  And there’s no more optimistic perspective than believing in your fellow man and woman to deliver the goods and generate positive returns on society’s capital.

Silver screen vixen Mae West was famous for saying “Too much of a good thing can be wonderful”, but she probably never ran across a bulled up Wall Street stock analyst.  And if she did, they probably didn’t talk stocks.  Over the last few years we’ve been tracking this group’s expectations for revenue growth at the 30 companies of the Dow Jones Industrial Average.  The original idea here was to follow the nascent global economic recovery as it filtered through corporate financial results in the period after the Financial Crisis.  That story played out pretty well in 2009 and 2010, as revenue growth ran a healthy 10-15% year over year.  It was a happy, sunny, simple time.

Since then, however, the storyline has shifted to a darker tone where optimism is a great travelling companion but it can’t read a map or figure out the rental car radio.  We can summarize this transition by looking at the recently completed and reported Q1 2014:

In May of last year, the Wall Street brokerage analysts that cover the Dow stocks were very optimistic on Q1’s top line growth.  Their consensus perspective was that 4-5% year over year growth was achievable.


In the following months, they gradually lost their courage.  In April 2014, with these companies about to report, their collective wisdom held that revenue growth would average 1%.


They still missed the mark; average revenue growth came in at 0.3% for the Dow names, and 0.5% for the non-financial names.  On the bright side, at least it wasn’t negative, as it has been off and on since 2012.

In short, optimism certainly has a place in equities, as I have described.  But since the end of the snap-back in corporate revenues in 2010, we have seen nothing but the same pattern noted in the points about Q1.  Analysts start out with high numbers and slowly reduce them to something more realistic as the day of reckoning arrives.  Another old Wall Street aphorism: “Never hire analysts. In a bull market you don’t need them, and in a bear market they’ll kill you.”

Which brings us to the current day.  U.S. equities are still up on the year (at least large cap stocks, anyway).  First quarter GDP was just as dismal as first quarter Dow stock revenue gains.  And the map light of optimism over future quarters still shines reasonably bright on domestic equities.  We can see this in the analysts’ revenue expectations for Q2 and Q3 2014 (see associated tables and charts immediately after this note):

The current consensus for Q2 top line growth is 2.5%, and 2.9% once you exclude the financial names in the Dow.  Despite a no-growth Q1, Street analysts have not really pared their Q2 revenue expectations since late last year.   The ex-financials estimate of 2.9% is actually an uptick – the first since last October.  Analysts clearly believe in the weather-related weakness explanation for sloppy Q1 sales.  The sun will (hopefully) come out tomorrow.  Bet your bottom dollar…


Analysts have also grown bolder about their Q3 expectations, which are now up to 3.9% as an average comp for the Dow 30 companies to last year.  This reverses a slow grind lower, which started at a 5% comp expectation in November 2013 and ended at a 3.6% expected improvement in top line growth last month.
It is still a little early to handicap Q4’s trends, but analysts are out with a 3.0% revenue comparison to last year’s fourth quarter.  Not much change over the last three months here.

Make no mistake – this is the single most important factor to consider when pondering the fundamental direction of U.S. stocks over the remainder of the year.  That’s because revenue growth fulfills the reason equities are worth owning.  Better sales drive better earnings and better returns on capital.  Should you own stocks here because analysts are optimistic about the balance of the year?  No.  The track record here is spotty at best.

The logic, however, that guides analysts to forecast a better Q2 and second half of 2014 is very much the same as that which defines the future direction of stock prices.  Without sales growth, equities just keep earning the same basic returns as they have in recent years.   What do you call a security where the cash flows are fixed?  Yes, a bond.  Only it is a bond that never matures.  And you probably don’t want that.

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Gamma735's picture

When will the music stop?

SAT 800's picture

"---things may work out better this time--" Yes, well; they might; and then again they might not. For some reason, I'm just not filled with a burning desire to invest money in something that "might work out better this time".  Probably, I'm just too old fashioned.

knukles's picture

Mae West Quantity Theory ...


If some is good
And more is better
The way the fuck too much is just about right

disabledvet's picture

Methinks Mae West dated nothing but Wall Street analysts which explains her wonderful one liners when it came to....just about everything.

In the meantime...as long as inflation is contained...the market will get a bid.

That doesn't mean you'll make money being long...or even trading this thing. But the only thing the market fears is inflation...no inflation=capital deployment.

TeamDepends's picture

“Suffering has been stronger than all other teaching, and has taught me to understand what your heart used to be. I have been bent and broken, but - I hope - into a better shape.”
? Charles Dickens, Great Expectations

fonzannoon's picture

I don't agree with this article. Earnings do not matter. I could pick any one of a bunch of stoocks to illustare this, but the best one is probably MCD. I mean their eranings are constantly horrific, but they have a 3% yield. So here is your MCD bond returns


Now if the 10yr keeps dropping, which way is MCD heading?

SAT 800's picture

I have no idea which way MCD is heading. I'm completely ignorant of this knowledge. This ignorance protects me from the delusion that I do know which way MCD is heading; and trying to collect the well-known "free lunch".

fonzannoon's picture

You also have no idea which way gold, silver, the 10yr and the S&P 500 is going. Nobody does. But you take the information out there and sack up and take your shots. Same as it ever was.


SAT 800's picture

Touche'  Very true. For some reason I regard the S&P500 as more predictable on a one week timeline than whatever MCD is, (I don't even know, or care); I assume it some kind of common stock; common stocks are so capriciously volatile that I definitely don't want to hold on to one long enough to try to cash in a dividend. I loved buying B of A at $5.00/ share; because it was a guaranteed profit. I've had a good time selling the wonder rally spikes in the S&P500 lately. I did get bit shorting the Long Bond; which is a little "calmer" market than the 10 yr. But the occasional stop loss is good for the soul. I like to wait most of the time and watch; what I'm waiting for is complete screaming madness in some price chart or another; then I'll pick a top or a bottom and try it out. I hate all forms and time lines of trend following. Is it not true that between you and your dividend lies the caprice of "management". This is something I've never been able to get interested in. The Silver and Gold markets are very soft and weak right now; but of course one can't say that on this forum. I won't short either one because of the "black swan" possibility; if something really serious happens the losses in a metals short could be very, very bad. I have a small short position in the Yen/USD cross, basis September based on Kyle Basses analysis. It's not working yet; but usually if a government wants to devalue it's currency it succeeds.

SAT 800's picture

Well, I'll be darned. MCD seems to be McDonalds hamburger shops. It's a great story; they're going to give all their surplus cash back to the stock holders in the form of dividends and stock buy-backs. What could go wrong ? I'm really tempted to short this turkey, but I see they've got ahold of the mass-minders by the ear and they're all following along with the bouncing ball. I'll just watch, instead; I wonder what will happen?

Goldilocks's picture

Eurythmics - Sweet Dreams (Are Made Of This)
http://www.youtube.com/watch?v=qeMFqkcPYcg (3:34)

SNAP! - The Power
http://www.youtube.com/watch?v=nm6DO_7px1I (3:50)

buzzsaw99's picture

equating sales growth with returns is just silly in this environment. just borrow the money and pay huge dividends.

SAT 800's picture

By golly, I think you're on to something there; I suppose you'd have to finesse the record keeping a little, but hell, what are accountants for, eh?

buzzsaw99's picture

by jove you deserve a really big bonus

power_shift's picture

It won't be long now before high gas prices and ACA take a huge bite out of those "high earnings." Tick tock fuckers...

SAT 800's picture

Tick Tock, Tick Tock, and then Sproing !! and all the little stock muppets find out thy've been Cuckoo Birds. I'm going to laugh, personally.

Grouchy Marx's picture

Valuations seem irrelevant any more. Shorters have discovered this. 

Nonetheless, once undeniable contraction is manifest, I do think the over valuations will get "noticed" and the bottom will fall out.