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Chicago, Apr.16, investment opportunities .- We haven't had much earnings growth the last two quarters, and consensus expectations for the Q1 earnings season are for modestly negative earnings growth. Investors haven't really cared much about the lack of earnings growth lately, and they don't seem to be losing any sleep over the expected Q1 earnings decline.
A major reason for the market's sanguine view of the earnings picture is that it's looking beyond the current period of weakness to a growth rebound in the following quarters, particularly in the second half of the year. My goal in today's write-up is to not only give you a preview of the Q1 earnings season, which ramps up this week, but also to comment on current consensus expectations for the coming quarters. Earnings matter. After all, of the many elements that have a bearing on stock prices, corporate earnings are one of the most influential.
As regular readers know, I have been skeptical of consensus earnings growth projections. Earnings can grow only in two ways - revenue growth and/or margin expansion. For the current second half 2013 and full-year 2014 consensus expectations to pan out, you need strong gains on both of those fronts.
But you can't have revenue gains without economic growth, and the economic growth picture doesn't appear to be that inspiring with the U.S. economy again headed towards a Spring Swoon. With respect to margins, companies have become very good at doing more with less. This has helped them expand margins. But that trend has likely played out already without much room for further gains down the road.
What is Expected for Q1?
Total earnings are expected to be down -1.8% in Q1 from the same period last year, with 9 of the 16 Zacks sectors experiencing negative earnings growth and two others barely in the positive column. This follows earnings growth of +2% in Q4 2012 and +0.5% in Q3. A combination of tough comparisons and weak guidance accounts for the mediocre growth outlook for Q1; the first quarter of 2012 produced the highest quarterly earnings total since the current earnings growth cycle started in 2009.
Technology and Finance, the two largest sectors in the S&P 500, reflect this growth challenge. Total Finance sector earnings are expected to be barely positive this quarter after many quarters of double-digit growth. The issue is even more widespread in Technology, where the problem is not restricted to a few major sector players as is the case within Finance. Outside of Construction, there is hardly any growth in any of the other sectors.
The actual results will most likely be better than these pre-season expectations; a function of corporate managements' track record of under-promising and over-delivering. That said, earnings growth has been steadily coming down for a number of quarters and a rather flat earnings growth rate in Q1 would not be that unusual.
What is Expected Beyond Q1?
When we look at the quarterly dollar earnings totals, we get a better sense of what is expected for the coming quarters. Quarterly earnings are expected to total $243.7 billion in Q1 2013, which compares to $248.1 billion in Q1 2012. This compares to an earnings total of $238.2 billion in Q4 2012. The expectation is that Q4 was the bottom and growth resumes from Q1 onwards. Current consensus expectations are for a quarterly earnings total of $256.5 billion in Q2, $265.2 billion in Q3 and $272.4 billion in Q4.
I didn't mean to bog you down with these big dollar figures, but the point is that consensus expectations are for a strong earnings rebound from Q2 onwards, particularly in the second half of 2013 and into 2014. In other words, total earnings growth ramps up +10.8% in the back half of 2013 from the first-half's +0.9% growth pace. And this second half growth recovery is then expected to carry into 2014, resulting in further earnings growth of +11.6%.
Driving the optimism seems to be the view that the forces holding down profitability in 2012 will abate in 2013, particularly in the second half of the year. But with margins already topped-out and revenue growth hard to come by due to the synchronized worldwide economic slowdown, these earnings growth expectations appear vulnerable to downward revisions.
My feeling is that second-half 2013 earnings growth expectations will start coming down as companies provide guidance in the coming days. It is hard to envision any significant earnings growth in a backdrop of challenged economic growth and limited margin expansion opportunities. So be skeptical of annual earnings growth expectations of more than 3% to 5% this year and next. Current consensus expectations are for growth of +6.7% in 2013 and +11.6% in 2014.
Putting It All Together
My sense is that the Q1 earnings season will not be materially different from what we saw in the last two quarterly reporting cycles. This means about two-thirds of the companies will beat expectations, earnings and revenue growth will essentially be non-existent and the overall tone of guidance will be on the weak side.
If we see a repeat performance, then estimates for Q2 (currently for growth of +3.5%) will come down, but estimates for Q3 (currently at +7.5%) and Q4 (currently at +14.5%) will hold up. As long as growth expectations for the second half of 2013 and full-year 2014 remain in place, the market's current Fed-inspired trajectory will remain undisturbed. But if management guidance turns out to be materially weaker, this will prompt estimates for the second half of the year to start coming down in a big way. It will be interesting to see if the market can hold onto its gains in the face of such a deteriorating picture. I don't think it could, but we will have to wait and see. ...
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