With the imminent launch of the Q2 earnings season, below is a summary of consensus for year-over-year top and bottom line performance. In summary, the outlook is for a 12% pick up in top line YoY (ex fins), and pretty much staying flat at that level of outperformance for the next 2 quarters, and for a 41% rise in EPS compared to Q2 of 2009 per Bloomberg consensus estimates. For those looking for further granularity, David Rosenberg presents a detailed break down sector by sector, and warns of the risks to betting it all on the earnings parade, even as analysts are once again at near all time record bullishness on stocks.As a reminder, the consensus view is for a 2010 absolute EPS of 82, and for a simply ridiculous all time record 96 in 2011, higher than the 88 seen all the all time high three years ago, when the economy had the benefit of a multi-trillion shadow credit system. Who knows, maybe the Fed can take over that full responsibility as well.
And Rosie's view on earnings, and why irrational bullishness is very much unwarranted:
Bottom-up analysts expect second quarter earnings to come in at 27% year-over-year growth, no change from the last few weeks but about five percentage points higher than expectation in early April. This is a major slowdown from the near 60% rate in Q1; however, but analysts have become increasingly more bullish even as the economy has apparently hit an inflection point.
We should see significant sector rotation for Q1 to Q2. While Financials led the way in Q1 (up over 370% partly due to very weak comps), Materials and Energy are expected to be the outperformers in Q2 at 91% and 72%, respectively (Q2 Financials results are expected to be much more modest, at 18%).
Analysts see a dichotomy in consumer-related earnings as well — Discretionary earnings are forecast to be close to 50%, while Staples are expected to come in at 5%. In fact, analysts have become progressively more bullish on Consumer Discretionary earnings over time — last October estimates were half of what they are today, at around 28%. The opposite is true for Staples — here analysts have continuously marked down forecasts from close to 10% last year to currently just over 5% now.
The laggards in Q2 are expected to be Utilities (-5%), Telecom (-2%) and Health Care (+5%).
Looking ahead to Q3, earnings are expected to come in around 25% — estimates have fluctuated around this point for several months. Financials are expected to be very strong, at 81%, and have also been continuously marked up (last year estimates were at 40% growth). Consumer Discretionary profits are at 20% and Staples are at 6%.
Revenue growth in Q2 is expected to be 9% and excluding energy are at 6%. Both top line performance and corporate guidance are going to be the key drivers in coming weeks. The biggest hurdles are in Energy and Materials — they are forecast to have strong top line growth, at 28% and 21% respectively; Financials are expected to see revenues fall by 7% YoY.
As for all of 2010, the consensus is at $82 operating EPS, and for a new record to be reached in 2011, at $96 — breaking the record of $88 three years ago. Good luck in seeing a further 30% increase in profits with nominal GDP rising at a 3.0-4.0% annual rate at best in the next six quarters and at a time when margins are already back to cycle peaks.
The flattening yield curve and prospect of a rebound in the unemployment rate cannot be good news for the Financials as well, in our view. Plus, credit problems continue unabated with the FDIC closing four more banks, bringing the year to date tally to 88 — on par to surpass the 140 financial failures in 2009.
As for the Consumer Discretionary group, the news is not good. Credit remains tight (see Borrowers Hit New Home-Loan Hurdles on page A3 of the weekend WSJ). With the Memorial Day boost to the chain store sales data out of the way for June, and even with that the trend was at the low end of expectations (3%), the weakness can be expected to be glaring when the July data roll out. Housing is still in a complete state of disarray (see Keep an Eye on Homebuilder Bonds for Clues to a Double Dip on page 15 of the weekend FT). There is also room for more wealth-destroying as home prices decline — the Economist runs with an article (on page 73) and a table showing the degree of overvaluation left (up to 11% in the U.S.A.; and 23% in Canada; not to mention over 30% in Britain and France; 50% in Spain!).
And, since Congress has been dragging its feet in terms of extending emergency unemployment benefits, we can expect to see around three million fall off the rolls by the end of the month — and along with that, an estimated $50 billion in annualized income transfers from Uncle Sam to the household sector. That’s akin to the Fed hiking rates five times in terms of a dampening impact on aggregate demand — and yet, because of the “steep” yield curve, nobody believes the economy can relapse (even though the last three recessions in Japan all occurred with the yield curve positively sloped, and guess why? Because it can’t invert once policy rates are at zero). And don’t forget, we are going to see upwards of 700,000 Census workers lose their job between now and September. While some will undoubtedly find work elsewhere, has this lost income been adequately factored into consensus forecasts as well? We think not. Double-dip or not, downside economic surprises are quite likely going to remain a dominant theme through the summer.
Moreover, households are going to have to start preparing for a big tax hit next year too, and across a variety of areas. The top two marginal rates are expected to rise (to 39.6% from 35.0% and to 36% from 33%). For the high-income taxpayer, the rate on capital gains rises to 20% from 15%; dividends will get taxes at the top marginal rate of 39.6%. The “death tax” is slated to come back next year and the President is seeking a 45% tax on estates above $3.5 million per person. Personal exemptions are to be phased out and deductions will be limited.
On top of that, a 3.8% surtax will be applied on investment income for high-income earners. All in, we are talking about a near 2% fiscal drag for 2011 at a time when the run-rate on real final sales (GDP excluding inventories) is barely more than 1%. Do the math — how exactly is the economy going to escape a relapse, unless Bernanke has another rabbit in his hat?