RIP Prince, but I thought it was a fitting title for my first blog since the end of 2016. If someone had bought around 1,000 more shares of any stock in the Dow Jones Industrial Average, we would have reached the vaunted Dow 20,000.
Anyway, I took some time off for the holidays to relax and read and I hope that everyone had a great end of the year. It was a crazy one, and I’ll be out with my end of the year thoughts soon with a blog and corresponding video. Until then, here’s what’s happening…
Earnings Season is Upon Us
Ahh yes, the quarterly ritual known as earnings season is here and it unofficially begins today with our old friend Alcoa. In reality, earnings are released all throughout the year so in order to break it all up, Alcoa’s earnings announcement is the traditional start to the quarterly earnings season. This week will offer up a parade of fourth quarter and annual profit reports from the world’s largest publicly traded companies.
It can be a volatile time in the market, but as we know, longer term corporate profitability is the biggest driver of stock prices.
Read that again.
Sure, we can get daily and weekly volatility that is inspired by various incidents, both home and abroad. I allude to my disdain for the day-to-day hyping of the news by the mainstream financial media, but the reality is that it has been the problems in Europe and in China that have hampered sentiment over the recent past.
As an aside – here are some of my more favorite TV moments from the past year.
But when these one-off happenings fail to alter the U.S. outlook, the focus returns to earnings and expectations of earnings. And what happens to the bottom line is heavily influenced by the economy.
So, how are earnings shaping up for the fourth quarter?
The short answer is…respectably. Especially relative to what amounted to an “earnings recession” over the past year or so. You’ll see that below represented by red bars in an upcoming chart, BUT DON’T SKIP AHEAD YET!
If we look at data going back over 100 years, the correlation between stocks and profits is over 90%. (+100% means the two variables move together perfectly, 0% means the two variables have no relationship, and -100% means they move in exactly the opposite direction.)
Take a look at the chart below from Charles Sherry. You’ll see that earnings in the fourth quarter (Q4) are forecast to rise 6.0% versus one year ago (green bar on the right). That is down from a forecast of 8.3% on September 30…which was the last day of Q3 2016.
But, as we’ve seen through much of the current economic recovery and expansion, a reduction of earnings forecasts has been quite common, as companies issue conservative guidance and analysts reduce their estimates. It’s an under-promise, over-deliver strategy for many firms…remember it’s always easier to clear the bar when it’s lying on the floor.
Now take a closer look at Q3 2016 in that chart. You will see that analysts were expecting a 0.5% drop in profits, but investors were treated to a 4.3% rise when all the numbers had been counted.
In other words, companies as a whole came in well ahead of expectations.
Want more good news? Well, diligent reader, since you didn’t skip ahead earlier, I’m coming back to tie it up on that earnings recession sentence. Just as important, the four-quarter earnings recession (caused primarily by the collapse in oil prices and the subsequent effect on profits among energy-related firms) is over, and growth is expected to accelerate in Q4.
If such growth materializes and actually exceeds current estimates, it seems likely to create momentum in the new year.
We’ll have a clearer picture in February. In the meantime, be on the lookout for my end of the year piece that we’ll be sending out soon.
Call with questions.
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