The Inexorable Disappointment Of The Earnings 'Hope' Cycle

Tyler Durden's picture

Summer is over. Analysts return to their desks amid a grand-tour of conferences, industry gatherings, and company meetings, and - as has happened on average for the last twelve years - expectations are notched down from first-half-of-the-year 'hope' that this-time-is-different. Barclays' Barry Knapp notes that while macro risks seem more balanced than last spring, equity investors face a considerably higher risk in that of elevated earnings estimates. Since 2000, the worst month for analyst estimate revision momentum (net revisions) is also October, followed by September and December (tied). It stands to reason (though it’s tough to statistically ‘prove’) that equity investors and analysts return from vacation, attend conferences, and cut their earnings estimates. This, in turn, contributes to increased volatility and negative returns. While many will be focused on broader concerns – the ECB meeting, German Constitutional Court, presidential polls and macro data – equity investors are likely to hear a consistent message from the ~180 conferences: the global and domestic economic outlook is not robust enough to justify 11% y/y earnings growth in 4Q12 or 12% in 2013.

 

Via Barry Knapp, Barclays: When Equity Investors Go Back To School

 

As was the case in April and July, current quarter (3Q12) estimates have in fact been reduced – in this case to roughly -3% y/y. Forward estimates remain quite optimistic though, with 4Q12 up ~11% y/y; consumer discretionary, financials, technology and materials are expected to lead the rebound to robust earnings growth. At this stage of the business cycle, we would expect earnings growth close to that of nominal GDP.  Our S&P 500 earnings forecast calls for 4% growth for both 2012 and 2013. Still, despite ample evidence that domestic growth is below its potential (~6%) and emerging markets are no longer a source of positive operating leverage, the consensus for 2013 remains +12%. In our view, the numbers need to come down; we suspect all those conferences will play a role in the seemingly inevitable rationalization.

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Most investors are cognizant of autumn’s seasonality in terms of returns and volatility; August, on average, has been the worst-performing month since 1989 and September the second, while December has been the best-performing month through that time...

 

...since 2000, the worst month for analyst estimate revision momentum (net revisions) is also October, followed by September and December (tied). It stands to reason (though it’s tough to statistically ‘prove’) that equity investors and analysts return from vacation, attend conferences, and cut their earnings estimates. This, in turn, contributes to increased volatility and negative returns.

Chart (via Bloomberg's Chart of the Day)

 

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With few signs of global growth stabilization and a reasonably soft, albeit more stable, U.S outlook, we were struck by expectations of a sharp acceleration in earnings growth (both 4Q12 and full-year 2012) in the domestically leveraged consumer discretionary sector and a return to growth in the globally geared materials sector. In both cases, estimate trends are down and net revisions, a leading indicator, are headed lower. Weekly chain store sales estimates for August, part of the second most important shopping season of the year, ‘back-to-school’, are well below last year. ICSC is forecasting 1 to 1 ½% y/y comparable store sales for the month (compared to +4.6% in August 2011), while the Redbook series is forecasting 1.7%. Consumer confidence has been falling as gasoline prices march back towards $4 a gallon. Estimates have fallen in the metals and mining names but chemicals remain at risk from the myriad of negative data points (China, in particular).

 

Thus, while many of us will be focused on broader concerns – the ECB meeting, German Constitutional Court, presidential polls and macroeconomic data – equity investors are likely to hear a consistent message from the ~180 conferences: the global and domestic economic outlook is not robust enough to justify 11% y/y earnings growth in 4Q12 or 12% in 2013.