As investors await the unofficial start of the second quarter earnings season, with the release of Alcoa Inc.'s results after markets close on Monday, some observers are looking a little further out and seeing clouds: UBS strategists have chopped their expectations for 2011 earnings for the S&P 500.
"Our Equity Strategy team is reducing our 2011 S&P 500 earnings estimate by 4 per cent from $92 (U.S.) to $88, but maintaining our long-standing 2010 estimate of $80," said the strategists in a note. "Our estimates are now below the bottom-up consensus analyst estimates by $2 and $8 for 2010 and 2011, respectively."
There is a lengthy list of reasons behind the chop: The strategists have lowered their expectations for U.S. gross domestic product growth, global fiscal tightening is on its way, greater government regulation will translate to lower profitability for some sectors (such as financial stocks and health care), the U.S. dollar is up and commodity price expectations are lower than their earlier assumptions.
"2010 second quarter results are likely to once again exceed expectations but we expect that the magnitude of the aggregate positive earnings 'beats' will be the smallest since the market bottom in March 2009," the strategists said. "Crucially, forward guidance will likely be more cautious than in recent quarters given the uncertain macro outlook."
Indeed, the UBS strategists believe that analysts are set to lower their forward earnings estimates, which will weigh on equities. They recommend sticking with defensive stocks - particularly consumer staple and utilities - where valuations are attractive and stocks have a history of outperforming when the economic backdrop is uncertain.
"While Alcoa 'unofficially' kicks off second-quarter earnings season...as the first member of the Dow Jones industrial average to report, 26 S&P 500 companies have already reported second-quarter numbers," the strategists said.
"The results from these early reporters (mostly companies with a May fiscal quarter-end) have been generally positive - with 73 per cent beating estimates, confirming that estimates are likely too low for the quarter. However investors were generally disappointed with the forward-looking outlook. As a result, this group of companies underperformed the market by 1.4 per cent despite the better-than-expected results. The early reporters have both confirmed our belief that estimates are too low for the quarter and forward estimates for 2011 are too high."