Investors are counting on earnings season for a second-quarter rebound after a harsh winter bit into corporate profits.
On Tuesday, Alcoa Inc. unofficially ushers in the spring earnings season when it reports its second-quarter financials, followed in the coming weeks by the quarterly deluge of corporate earnings reports.
Recent quarters have seen companies easily beating low-ball earnings estimates. “It seems like the bar is still quite low,” Bank of Montreal chief economist Doug Porter said. “I think we’ll see the typical pattern.”
That bodes well for investors banking on earnings season’s recent reputation as a reliable source of fuel for the stock market.
The last several quarters have been preceded by waves of profit warnings prompting analysts to cut their forecasts. Prior to the first quarter of this year, 92 S&P 500 companies issued negative guidance compared with just 21 that revised to the upside, according to FactSet.
Then 74 per cent of the companies in the index ended up beating those expectations. Though the exercise is a predictable one, investors love a good beat, and corporate earnings have sustained the bull market amid recent volatility in economic indicators.
Last week saw record highs for each of the S&P 500 index, the Dow Jones Industrial Average and the S&P/TSX composite index.
“It’s been such a strong market that even if a company missed, you had a reaction to the downside, but then you see quite a bit of support coming in,” said Jennifer Radman, senior portfolio manager at Caldwell Investment Management.
The first quarter’s rash of negative guidance was mostly blamed on a brutal winter, which spread its misery across a wide geographical and sectoral range. Earnings in that quarter came in at 2.1 per cent, which is respectable considering the U.S. economy contracted at an annualized rate of 2.9 per cent, the U.S. Commerce Department reported in late June, marking the economy’s worst quarter in five years.
Most economists are predicting an economic rebound of similar size in the second quarter, Mr. Porter said. “I do think there was a significant step up in the economy from a pretty tough start to the year and I think that will be reflected in second-quarter earnings.” FactSet forecasts second quarter earnings growth of 5.1 per cent.
In the last couple of weeks, a number of U.S. economic indicators began pointing in the same direction. Auto sales, home sales and consumer confidence all ticked up, while, perhaps most important, the U.S. unemployment rate fell to a six-year low of 6.1 per cent in June.
“If companies are willing to hire, they’re usually more willing to spend on machinery and equipment as well,” Mr. Porter said. “I suspect that nice spring we had for jobs likely showed up in capital spending.”
U.S. business investment took an unexpected 1.2-per-cent dip in the first quarter, and investors will be looking to earnings reports for indications of a rebound.
“Capital spending remains a critical investment debate, and we are looking for signs that companies within technology, industrials and consumer see the need to add capacity,” Adam Parker, chief U.S. equity strategist at Morgan Stanley, said in a note.
On a related note, investors will want confirmation that first quarter weakness was primarily a weather-related phenomenon, particularly in the sectors hardest hit by winter, Caldwell’s Ms. Radman said.
“People will be really looking at retailers, because they really lagged. It goes back to whether it’s a structural demand problem, or was it that people just didn’t go outside.”