April 28--This has to be the classic good news-bad news story.
The bad news is that U.S. companies are about half way through reporting profits for the first three months of this year and the results are disappointing.
In fact, this could be the first time since the third quarter of 2012 that growth has declined, said John Butters, earnings analyst at FactSet. Of course, investors buy stocks to see profits grow. So this is a bad sign for investors, especially because stocks are on the pricey side. If investors conclude that profits will keep disappointing them, they may decide they overpaid for stocks.
But the good news is that the profit picture could have been worse. Just a month ago, analysts were so skeptical about growth prospects that they estimated profits would decline 4.6 percent in the first three months of this year. When Butters tabulated expectations at the end of last week, he found analysts less worried after digesting the earnings reports that have been released so far. Instead of a 4.6 percent decline in profits, they were expecting only a 2.8 percent decline.
But there is no doubt that the concerns investors carried into this reporting season are valid. The plunge in oil prices has hammered profits for energy companies and hurt companies that sell equipment to energy firms. Also, because the U.S. economy is in better shape than that of Europe and many emerging markets, the U.S. dollar is strong and a drag for large multinational companies that depend on selling abroad. Lake Forest-based Tenneco this week joined a wide array of companies that have noted that the strong dollar is having a harsh impact on sales.
Investors are watching results closely with the concern "that weak energy prices, paired with a strong U.S. dollar, could be the tag-team to bring the first year-over-year decline in quarterly earnings since the third quarter of 2009," Thomson Reuters earnings analyst David Aurelio said.
The good news is that while energy companies have been hit hard and multinationals are paying a price in dollars, overall the Standard Poor's index of large companies remains profitable if the drag from the energy sector is excluded. Without energy companies in the mix, earnings growth increases to 8.7 percent, Aurelio said. That sounds impressive, but Apple is a powerhouse of profits and it's skewing the growth picture for the index. Without Apple's impressive earnings, profits for the Standard Poor's 500 would be down 1.6 percent for the last quarter, Aurelio said.
Of course, earnings don't give a complete picture of the struggles companies are going through. Sales for the large companies that make up the Standard Poor's 500 are expected to be down about 3 percent for the quarter ended in March.
Smaller companies, which focus on the U.S. market without selling abroad, are faring better. Sales for small companies are expected to be up 8.1 percent, according to Bank of America Merrill Lynch strategist Steven DeSanctis. But while sales are stronger than for larger companies, small-company stocks could be vulnerable because small companies -- like large companies -- are reporting sales below expectations, he said.
"We think that earnings will be mixed and we would even say one of the weaker in recent history. We think that the reporting season needs to be very strong to support where valuations stand today."
The biggest losers in large and small companies are energy companies.
While many large technology and industrial companies have been able to meet expectations for profits, the concern is that they are "missing on sales," said Bank of America Merrill Lynch strategist Savita Subramanian.
And as company executives have talked about future growth, they have been apprehensive -- suggesting analysts may still be overly optimistic despite ratcheting back expectations considerably.
"Expectations for the out-quarters may still need to come down," said Subramanian, noting particularly weak guidance about the future from executives in industrial, technology and consumer discretionary companies.
Besides the strong dollar and oil companies cutting back on purchases of equipment, industrial companies have been hurt by a slowdown of China's economy and slow U.S. construction, Deutsche Bank strategist David Bianco said.
He doesn't think the pressures are over. Rather, they are "squeezing industrials earnings in a way that is likely worse in the second quarter and long-lasting," Bianco said.
He noted that 70 percent of industrial companies have missed analysts' estimates for both profits and sales. The biggest misses were in companies that make machinery and defense industry products.
Even though analysts have been slashing their earnings estimates this year, Bianco thinks analysts will continue to cut expectations for this year. Companies will face further pressure, he said, as the Federal Reserve raises interest rates and the U.S. dollar gets stronger.
He anticipates that industrial companies will be most at risk. In a report he advised clients to "tilt to defensive stocks and raising cash," because "we expect an 8 percent S dip near term" as estimates are cut and good job reports force the Fed to raise rates.
Surveys of analysts suggest that most think the Fed might start raising rates this fall, and they may pick up additional hints as the Fed concludes a two-day meeting Wednesday.
gmarksjarvis@tribpub.com
