The blame game is in full swing this earnings season – and we’ve only just got started. So far rising wages, China, new credit cards and even the pope have been brought up as excuses for companies missing their financial targets. And it may be about to get worse.
To some extent this is business as usual. Chief financial officers and CEOs rarely blame themselves when profits fall short of the levels that Wall Street expected, or that previously promised.
Exporters point to the high value of the dollar, which makes it tough for an exporter to compete against rivals in foreign markets. A favorite for retailers is to pin the blame on the weather: it’s either too hot or too cold. The banks consistently blame problems with trading revenues: if only (cue gigantic sigh) market participants would speculate more and take more risk, then just maybe volumes would go up, and along with them, profits at banks like Goldman Sachs, which missed the mark last week.
But it’s time to ask a tougher question: not just what’s to blame, but what’s responsible for those factors, as companies get more and more creative in finding fault elsewhere. The third quarter has seen this blame game reach new creative heights.
Consider Walmart. While the company said many factors will contribute to a 6%-to-12% drop in earnings in its current fiscal year, including the pesky dollar, the market chose to emphasize one of those: the impact of raising employee wages. Perhaps because many media commentaries focused on the unusual reason for the declining earnings estimates rather than the (yawn) normal and boring one (the dollar) or even than to the bigger difficulty of how move the dial at such a massive company in the first place, the company’s stock suffered its worst selloff in decades in response to the announcement of disappointing earnings announcement.
But at least wages and a weak dollar are a substantive reason for disappointing earnings. Netflix CEO Reed Hastings decided to pin the blame for sub-par performance at the video streaming and DVD rental behemoth on the long-awaited change to new, more secure chip-based credit cards in the United States. Seems as if subscribers weren’t so eager to watch Orange is the New Black or House of Cards, after all: they forgot to give Netflix their new card numbers when the switch happened.
So far my personal favorite “blame game” excuse for the third quarter, however, would have to be Così, Inc. The sandwich chain actually issued a press release containing a statement that “business interruptions resulting from the Pope’s visit on September 22–26, 2015 negatively impacted 30% of our Company-owned restaurants”. Yup, the public may have loved Pope Francis; just don’t ask Così’s CEO, RJ Dourney, or its shareholders.
But the winner for the year might have to be Tesla Motors, the high-concept luxury electric car manufacturer with the sometimes high-flying stock. At the beginning of 2015, it actually blamed disappointing delivery figures of its Model S automobiles (a much-watched metric) on the fact that its customers were on vacation. Yes, you read that correctly.
The wackier the explanations get for a missed earnings or revenue number, the more our Spidey senses should start to tingle. Especially if more and more companies start to play the blame game and have to explain those shortfalls.
The fact is that some pundits are starting to wonder whether the good times in the US stock markets may be over.
Even before the Chinese market began to crash in June, the bull market for US stocks was already long in the tooth: six years old, and counting. Sales outside of the US market account for nearly half of all revenues of companies in the Standard & Poor’s 500 index, so it wouldn’t be surprising if the dollar’s strength puts a big dent in their profits. Even before China’s stocks went into freefall, the country’s economy had already weakened, taking a toll on global demand for manufactured goods and more dramatically, for metals and agricultural commodities. Throw in some fears about slowing US employment and economic growth, and it starts looking like the party is definitely over.
Doubtful about that? Just take a look at the IPO market, that barometer of market exuberance and irrationality. Shares of Shake Shack, one of the year’s top IPOs, may still be trading at $44, more than double the company’s $21-a-share initial offering price, but that’s well below their peak of nearly $97.
Meanwhile, the IPO of payment processing firm First Data – the largest initial stock issue of 2015 – fell flat when it came to market last week, backed by private equity firm Kohlberg Kravis Roberts. The deal did get done, but at only $16 a share, below its target range of $18 to $20.
Typically, when one window – to the public market – closes, another one opens. And indeed, the pace of mergers and acquisitions has reached an almost frenetic level, at least by dollar value, with the proposed Dell acquisition of EMC ($67bn) being one of the biggest and most recent announcements. If you’re an M&A banker, you’re already touring new condos and putting in orders for a new Tesla, in anticipation of the size of your 2015 bonus. All too often, however, a bull market in M&A is the last stage of a bull market in stocks for the rest of us.
While the exuberant stage of the rally is definitely at an end, that doesn’t mean that the corporate profit engine has stalled. Greg Harrison, senior research analyst at Thomson Reuters, notes that while Thomson Reuters I/B/E/S data now calls for companies in the S&P 500 to report a 3.9% decline in earnings for the third quarter, coupled with a 3.7% decline in revenue. “That looks quite a bit weaker than in previous quarters, especially the revenue, which usually has been in positive territory, or at worst has been flat,” says Harrison. And the outlook for the fourth quarter, which ends on the last day of 2015, based on early forecasts by analysts and company CEOs and chief financial officers, has just turned negative as well.
But just as we can draw too much from attempts by individual companies to explain away a bad quarter’s earnings reading too much into these broad market numbers is a dangerous game too. For starters, the data moves rapidly. “The third quarter profits number was down 4.6% only a day or two ago, until better numbers by many banks brought it up,” Harrison explains.
Then, too, once you remove the troubled energy stocks from the data, the earnings picture suddenly looks much, much brighter. Absent the troubled oil and gas companies S&P 500 companies would be reporting a 3.7% gain in profits. By the first quarter of next year, when weak energy earnings will be compared with weak energy earnings, that growth rate could be as high as 5.1%, Harrison calculates.
The third quarter of 2015 may well go down in history as the quarter when we realized that this bull market – as difficult, grumpy and volatile as it has been over the last six years – won’t continue indefinitely. For now, much as we may worry about everything from when the Fed raises interest rates to what happens next in China, those issues are not yet showing up in the economic data or corporate information that drive stock prices. Instead, investors are fussing about Walmart’s pay practices and – God help us – whether or not consumers are fast enough in giving Netflix their new credit card numbers. If anything, that should reassure us.
Still, we may want to fasten our seatbelts. Because from here onwards, the ride is almost certainly going to get bumpier.
