Slowing economic growth in Europe and in emerging markets such as China is expected to have hurt corporate performance in the fourth quarter, as reporting season unofficially kicks off next week in the U.S.
First at bat is Alcoa Inc., whose results on Jan. 9 are expected to set a negative tone, after the company announced Thursday that it will close 12 per cent of its global smelting capacity. The aluminum giant’s customers – from beverage producers to aircraft manufacturers – have been cutting demand in response to weaker economic conditions in Europe and Asia, leaving Alcoa with high inventory in an environment of falling aluminum prices. As a result, expectations for Alcoa have plummeted over the last month, and many analysts now expect that the Pittsburgh-based company will post a fourth-quarter loss.
Broad market expectations have suffered a similar downward trend. On Oct. 3, the consensus estimate for fourth-quarter earnings growth was 14.6 per cent. Today, it is just 7.5 per cent, despite the fact that third-quarter results topped analysts’ forecasts.
This decline in confidence is the fastest in three years, and if the new forecasts prove accurate, the last three months of 2011 will represent the first quarter of single-digit earnings growth after eight consecutive quarters of double- and even triple-digit increases, according to Ed Yardeni, president and chief investment strategist of Yardeni Research Inc.
Numerous forces appear to be weighing down expectations, including weaker global demand. Even as the U.S. economy shows signs of recovery, the outlook for Europe and emerging markets has been softening. Many now think that Europe might have already slipped back into recession.
In addition, higher energy prices – up 9 per cent in 2011 – and a strong U.S. currency are acting as a drag on performance. About 15 per cent of revenues among members of the S&P 500 index come from overseas operations, said Sam Stovall, chief investment strategist at Standard & Poor’s in New York.
The effect of these headwinds has already been seen on the Street. Negative revisions to fourth-quarter guidance have outpaced positive ones by a factor of 2.5 to 1.
On Thursday, J.C. Penney Co. cut its profit forecast for the end of 2011, citing weak holiday sales. Among other companies that have lowered guidance for the three-month period are Intel Corp., DuPont & Co., Corning Inc., Altera Corp. and Texas Instruments Inc.
But Mr. Stovall said it’s important to remember that analysts have been a bearish group this year and their expectations going into each prior quarter in 2011 proved to be substantially below what companies actually delivered. In the third quarter, for example, S&P 500 companies reported an average increase in earnings of 17.5 per cent, compared with consensus expectations as low as 12.5 per cent.
“I wouldn’t be surprised if earnings came in better than expected,” he said. “But I would be incredibly surprised if they ended up equalling what we saw in the third quarter.”
Relatively weak earnings growth in the last three months of the year is unlikely to depress stock prices further, Mr. Stovall added. S&P 500 companies are trading at an average price-to-earnings multiple of only 12.7, which represents a 29-per-cent discount to the 18 multiple they have averaged since 1988, he said.
Higher oil prices will likely make energy stocks the stars of the fourth quarter. The consensus among analysts is for earnings-per-share growth of 24 per cent, although that figure is a far cry from the 62-per-cent rise registered in the third quarter.
Financials are expected to book the second-best performance, posting earnings-per-share growth of 10 per cent, thanks in part to the freeing up of reserves that regulators had earlier mandated.
The telecommunication sector is expected to deliver the worst performance, reporting a decline in earnings-per-share of almost 12 per cent. Thanks to their stable cash flows and rich dividends, telecom stocks proved the favourite of equity investors seeking safety and income in 2011, surging about 20 per cent through the year.
“Sometimes people do irrational things when they are worried about the markets,” Mr. Stovall said.