Europe's struggles again dominated U.S. stock market trading Thursday, while investors were relieved by American retail and jobs reports.
What U.S. investors may be overlooking, though, is a rash of companies with disappointing guidance for the fourth quarter. And if you think the fourth quarter could be bad, it could get worse in 2012 as earnings and sales forecasts get trimmed.
Before the start of trading, retailers Target and Costco Wholesale published same-store sales for the critical holiday month of December. According to Thomson Reuters, sales rose 3.4 per cent in December, slightly better than estimates for an increase of 3.3 per cent.
But along came a wave of earnings warnings. Target now expects fourth-quarter earnings of $1.35 to $1.43 (U.S.) a share, below consensus estimates of $1.48. JCPenney and American Eagle Outfitters did the same.
As Bespoke Investment pointed out Wednesday, fourth-quarter earnings estimates have been trickling lower since Sept. 30, so the weak fourth-quarter guidance from retailers isn't entirely a surprise.
Bespoke noted that fourth-quarter earnings estimates have dropped from an expected growth rate of 14.1 per cent to a lowly 6.2 per cent by Jan. 3. While energy should see earnings growth of 21 per cent in the quarter based on estimates, the telecom, materials and utilities sectors should see declines.
Retailers weren't alone in disappointing investors with their quarterly guidance today. Wireless technology company Rogers and semiconductor maker Mindspeed Technologies , too, were also out with fourth-quarter sales guidance below estimates.
Investors should be worried, though, that the weak outlooks are extending beyond the most recent quarter. We're starting to see 2012 guidance coming in far below consensus estimates, with Barnes & Noble an example from today. Buried in a press release from the company that carried the headline "Barnes & Noble Reports Record NOOK Sales," the bookseller lowered its 2012 outlook for sales and earnings, throttling the stock more than 20 per cent.
Barnes & Noble wasn't alone. Drugmaker Eli Lilly offered a very weak outlook for 2012 earnings and its shares tanked. Petroleum refiner Tesoro also warned about a fourth-quarter loss and said earnings for 2012 would come in well below analysts' forecasts. Not all of the news was bad, though, as hard-drive makerSeagate Technologies offered a fiscal third-quarter sales outlook that impressed investors, sending shares higher.
John Butters, senior earnings analyst with FactSet Research, says earnings estimates for 2012 have been falling steadily since the summer. Six months ago, Butters says the year-over-year earnings growth rate for S&P 500 companies stood at 14.5 per cent, and it's now at only 10.4 per cent.
For context, Butters says the earnings growth rate for 2011 fell by 21.9 per cent from June 2010 through December 2010. The largest decline in most recent history came between June 2008 and December 2008, when forecasts for 2009 earnings were slashed by 65 per cent.
With the fourth-quarter earnings reporting season set to kick off next week, should investors brace for more disappointing full-year guidance from companies? "It's certainly possible, but it's all about the outlook for the year," Butters says. "The estimates have already come down quite a bit. A lot of the movement will come from corporate guidance."
Michael Sheldon, chief market strategist with Stamford, Conn.-based RDM Financial, says the issue is that there is an uncertainty about how much Europe is hurting global economic growth and profits.
"The estimates are likely to continue to come down for a range of different companies. The more cyclical ones with the exposure to Europe are probably most at risk," Sheldon says. "The bigger question is where they stabilize. That will help determine what P/E level the investors are willing to give to the market. Until there is more visibility, P/E levels are likely to be below historical trend."
A few months ago, analysts were expecting earnings of $108 during 2012 for S&P 500 companies. That number has now come down to about $105, which would give the S&P 500 a multiple of 12 times earnings. Historically, the price-to-earnings ratio for the broad index has been closer to 16.
"When you're in a trading range or a bear market, which we are in now, P/E levels remain below average or decline," Sheldon adds. "One of the big arguments for 2012 is what profit margins will be. The current consensus is that profit margins will continue to expand, but that's highly unlikely because of the global slowdown."
Robert Pavlik, the New York-based chief investment strategist for Banyan Partners, is also skeptical of how sustainable the elevated estimates can stay. He notes the discrepancy between estimates for a 4 per cent increase in revenue for S&P 500 companies in 2012 while the bottom-line is forecasted to increase 10.5 per cent.
"You're going to drive 10 per cent earnings on 4 per cent revenue growth? It seems high, it really does," Pavlik says. "With these troubles in Europe and China and some of the emerging markets, getting up to $106 in earnings this year may be a little difficult. With companies topping out on what they can drive out of their current workforce, how much margin expansion can there be?"
The bad news could get worse, too, if the dollar continues to gain ground on the €.-After a flurry of negative headlines out of Europe over elevated borrowing costs, the euro fell to an 11-month low against the dollar. A stronger dollar would impact companies that export goods overseas because it would be more expensive for foreign consumers to buy U.S. goods.
"If the dollar continues to strengthen, that's not at all beneficial," Pavlik says. "It just shows that you have to be selective in your stock picks. You can't just buy the entire market. You have to find areas that are working. You have to look at where the impact from the problem areas of the world will not be as substantial."