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(Alex Brosa)
(Alex Brosa)

Why this earnings season could be rough Add to ...

The third-quarter earnings season is under way, now that Alcoa Inc. kicked things off with its report on Tuesday evening. Its shares were down 5 per cent on Wednesday in afternoon trading, which suggests that the reporting season could be a slog.

But don’t think this is all about Alcoa. Jonathan Golub, a strategist at UBS, broke down the season into three components – growth, surprise and guidance – and he expects none of them to deliver news that can be considered upbeat. This could affect the stock market, and it could have an impact on the U.S. Presidential election.

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“Generally speaking, investors tend to focus most on surprise and guidance,” he said in a note. “Voters – concerned about jobs – will likely tune in on the current earnings recession, and indications from corporate management about the difficulties of operating in the current environment.”

On earnings growth, expect the biggest year-over-year decline since the bull market began in 2009. He predicts that S&P 500 earnings (after stripping out financials from the index) will decline 4.1 per cent. That follows a 1.5 per cent decline (also after ignoring financials) in the second quarter.

“Weaker economic data over the past 12-18 months has steadily eroded the growth outlook,” Mr. Golub said. “ Unfortunately, this weakness is relatively broad-based. More specifically, earnings are now expected to come in lower than 3Q11 in 5 of 10 sectors, with the greatest contractions in Energy and Materials.”

Mr. Golub points out that it is difficult to predict surprise, or the likelihood of companies producing better-than-expected results, or strong “beat” rates. However, he uses the past for some help. The downward revisions to earnings expectations have been particularly severe prior to the current reporting season – and large downward revisions go hand-in-hand with poor beat rates.

But corporate guidance could be the key theme to this reporting season, and it is particularly murky.

“We believe that the greatest challenge for companies today is an unprecedented level of uncertainty ranging from regulation and monetary policy to inflation and global growth slowdown,” Mr. Golub said. “These uncertainties make it particularly difficult for companies to operate their businesses, hire workers and generate higher profits.”

He trotted out three recent examples from key executives from FedEx Corp., Cummins Inc. and Nike Inc. For example, here’s what Cummins‘ chief executive had to say:

“We continued to see weak economic data in a number of regions during the third quarter increasing the level of uncertainty regarding the direction of the global economy. As a result of the heightened uncertainty, end customers are delaying capital expenditures in a number of markets, lowering demand for our products.”

What’s scary is that these three companies have been suffering far more than the broader market this year, making their challenges look like leading indicators. FedEx stock price is down about 8 per from its high in 2012, Cummins is down 31 per cent from its high and Nike is down 17 per cent from its high.

 
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