Troubling trends to emerge from upcoming Canadian earnings season

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There are weaknesses lurking within the rebound in Canadian profits.

The coming reporting season promises to deliver another huge jump in quarterly corporate earnings, at least set against last year.

But easy comparisons may be obscuring otherwise-deteriorating profit patterns, as the latest flare-up in the global oil glut keeps crude prices low.

"I think investors are going to be confused over the next few weeks," said Vincent Delisle, a portfolio strategist at Scotia Capital.

Many of them may be encouraged by what is projected to be an earnings increase of nearly 20 per cent over the same quarter last year.

"But we're already seeing negative revisions in resources," Mr. Delisle said. "The market is driven by revisions."

Consider that a strong first quarter for profits, combined with a resurgent domestic economy over all, have entirely failed to elevate Canadian stocks this year.

Companies in the main Canadian index posted an increase in first-quarter profits of almost 30 per cent over last year.

Meanwhile, the Canadian economy added 45,300 jobs in June, four times the number analysts had expected, and marking the seventh straight monthly increase, according to data released on Friday.

And yet, the S&P/TSX composite index is one of the worst-performing developed market indexes so far this year.

Dead last by some rankings, the domestic benchmark is down marginally in a year of near-universal global stock gains.

Not coincidentally, over that time, the market has moderated its expectations for Canadian earnings.

Last December, equity analysts collectively anticipated that second-quarter 2017 profits for S&P/TSX composite index companies would total more than $235 per share, according to Scotia data. That figure has fallen steadily and now sits almost 10 per cent lower.

The culprit is by now a familiar nemesis to Canadian investors.

Last December was the first time West Texas intermediate hit the $54 (U.S.) mark since the summer of 2015.

Since that peak, oil prices returned to bear market territory as surging U.S. shale output outweighed OPEC's production restraints. A recent AltaCorp Capital report called oil investor sentiment "among the worst we can remember." It's been a double whammy for the sector when factoring in the Canadian dollar, which has gained nearly five cents in value against the U.S. dollar over the past two months.

Energy stock analysts have reacted by steadily paring back their earnings growth expectations for the sector.

And it's that kind of shift that alters the assumptions priced into the market, even though the numbers might look good on a headline basis.

For instance, the energy sector is still expected to post an increase in second-quarter earnings of 84 per cent over last year, according to data from Thomson Reuters.

That's not far off how the first quarter shaped up, when oil and gas profit more than doubled, making it by far the most-improved Canadian sector, by that measure. But in terms of price performance, the energy sector is down by 16.3 per cent year to date, making it the worst-performing component of the S&P/TSX composite index by a huge margin.

It's easy to see how the current Canadian earnings backdrop can appear supportive of equity values. Across almost all sectors, year-over-year profits have sharply rebounded from the oil shock. In addition to higher crude prices, earnings have been fuelled by stronger global growth, and a pick-up in Canadian employment.

Even after the latest oil swoon, Canadian earnings for all of 2017 are sure to see double-digit growth over last year. In fact, energy earnings would need to come in 32 per cent below current estimates for the fiscal 2017 earnings to fall below 10 per cent growth, according to David Aurelio, an analyst at Thomson Reuters.

But comparing to last year, when the trough of the crude oil sell-off was hit, makes everybody look good, Mr. Delisle said. "If you're only looking at year-over-year, you're talking about stuff that no longer matters."

Alternatively, when compared sequentially to this year's first quarter, energy sector earnings are more likely to decline.

And as long as the oil market is providing fodder for negative revisions, the S&P/TSX composite index is likely to struggle, the recovery in non-energy profits notwithstanding, Mr. Delisle said.

"The other 80 per cent of the index, we're quite comfortable with. But oil needs to rebound if we're to have a better second half of the TSX."