First-quarter earnings season unofficially kicks off Tuesday when aluminum giant Alcoa (NYSE:AA) releases results. The market is girding for the most disappointing bottom-line figures in years. Fortunately, the market doesn’t care about bad news (or even good news) as much as it dislikes surprises, meaning dismal quarterly numbers don’t predetermine a sell-off in stocks.
But a weak or worse-than-expected earnings season won’t do the market any good, either.
The rate of first-quarter earnings growth for the S&P 500 for stands at 3.2%, according to data from Thomson Reuters, but even that single-digit figure is deceiving. Exclude Apple (NASDAQ:AAPL) — the largest publicly traded company in the world — and the S&P 500’s overall growth rate is forecast to be just 1.8%.
That would mark the most tepid year-over-year earnings growth since the end of the financial crisis, according to data from S&P Capital IQ, and it represents a sharp pullback in analysts’ expectations. As recently as September, Wall Street, on average, forecast earnings growth of 10%. But higher energy prices, recession in Europe, slower growth in China and corporate profit margins that have already peaked have since hurt prospects for corporate profits.
True, seven of the 10 major sectors in the S&P 500 are expected to see an improvement in earnings relative to the first quarter of last year, but the gains will be muted, according to Thomson Reuters. Indeed, at 10.6%, only the industrials sector is forecast to generate double-digit profit growth. Consumer discretionary and financials are expected to come in No. 2 and No. 3, at 6.6% and 6.5% growth, respectively.
Meanwhile, the materials sector is forecast to post a 14.7% decline in year-over-year earnings. Telecoms are seen logging a 14.1% drop in earnings, while utilities are expected to dip 3.1%.
Also troubling is the ratio of companies releasing bad news ahead of earnings, versus those reporting good news.
In the so-called pre-announcement season, there have so far been 83 negative pre-announcements regarding first-quarter earnings, versus 28 positive pre-announcements, according to Thomson Reuters. That makes the negative-to-positive pre-announcement ratio 3.0 — the weakest reading since the fourth quarter of 2008, during the depths of the financial crisis.
If there’s a silver lining, it’s that the weak first-quarter numbers are hardly unexpected and should therefore already be reflected in share prices. (It also doesn’t hurt that expectations are very low, leaving companies room for error and upside surprises.)
Additionally, stocks appear cheap, with the S&P 500 trading at a forward price-to-earnings ratio of 13. That’s about the same level it hit during the depths of the bear market. It’s also well below the long-term average of more than 16. As such, bargain valuations should help put some floor under shares.
However, as we noted in our second-quarter outlook, the market just enjoyed its best first quarter since 1998 — and stocks never move in a straight line. After coming so far so fast, don’t be surprised if stocks suffer through a listless earnings season or even sell-off.
Weakening U.S. and international economic data appear to have investors eschewing riskier assets such as stocks, at least for the time being. Unless first-quarter earnings surprise to the upside, the risk-off trade may be with us for a while longer.
