ALL ABOUT GUIDANCE
It’s always about guidance as stocks trade more on expectations for future quarters than on results for a quarter that ended. Since the Great Recession, earnings estimates for the next 12-months have typically fallen 2–3% during earnings season. During first quarter 2016 earnings season, the estimate reduction was at the low end of that range—an encouraging sign. We believe we will see a similar result this quarter for several reasons:
• Better growth. We continue to see 2–2.5% GDP growth for the second half of the year despite stalled overseas growth, the Brexit-related tightening of financial conditions (via the stronger U.S. dollar), which we expect to be short-lived, and U.S. election uncertainty that will be with us for the next several months. This growth pace is supportive of a return to high-single-digit earnings gains by year-end.
• Easing drags of the dollar and oil. The significant drop in earnings estimates early this year was largely due to weak oil prices and the strong dollar. Even with the post-Brexit dollar rally, these drags are easing considerably and increase the chances that companies are able to at least maintain their outlooks through year-end and into 2017.
• Favorable pre-announcements. The ratio of companies pre-announcing negative results relative to those pre-announcing positive results (2.3) has been more favorable during the second quarter 2016 than in the prior quarter (3.8) and the year-ago quarter (4.3). The ratio is also better than the 20-year average of 2.7.
• Estimates held up well late in the quarter even post-Brexit. Estimates for the second quarter of 2016 and the next year held up very well in June 2016, even following the June 23, 2016 Brexit vote, after which many economists reduced their European and U.K. economic growth forecasts and currencies experienced extreme volatility. Consensus estimates, which have fallen less than 0.2% since the vote, are calling for a 10% increase in S&P 500 EPS over the next four quarters, so we would view a number near this or slightly lower after earnings season is over as a positive surprise.
These factors suggest that high-single-digit earnings gains in the fourth quarter of 2016 are potentially achievable (consistent with consensus estimates), in our opinion, and can help support modest stock market gains in the second half of 2016.
CONCLUSION
The earnings recession will likely continue with second quarter results. Although the decline is likely to be smaller than the first quarter’s and suggest a trough is in, there will not be much good to say about the results. But better times may lie ahead. U.S. economic growth has started to pick up, the drags from the U.S. dollar and oil are starting to abate, Brexit appears unlikely to hurt U.S. companies all that much, and we generally expect guidance to be pretty good. We continue to expect a second half earnings rebound to drive further stock market gains in the second half of 2016.
Burt White is chief investment officer for LPL Financial.