Happy 2Q2015! A new quarter means another earnings season, and this may be one of the most impactful ones in recent memory. In the larger context of a weakening macroeconomic picture, punctuated by today’s lackluster jobs report, earnings are likely to weigh heavily on the near-term fortunes of asset indexes. From where we sit, the river runs swift with dangerous currents. We look first at the macro context, then the unfolding earnings picture, and conclude with thoughts about navigating the approaching rapids.
Jobs, Prices and Rates
The “consensus economist” contingent was caught like so many deer in the headlights this morning. The Bureau of Labor & Statistics brought forth a dismal report from what has hitherto been the go-to place for good news: the jobs market. 126,000 payroll gains for March, plus a net downward revision of 69,000 for January and February, does not a case for growth make. Wage growth remained more or less where it has been, just barely keeping up with (low) inflation. The good news, such as it is, from a bad jobs number is yet another reason to believe the Fed will push the rate decision further back towards the end of the year at the earliest. Normally that is like a sprinkling of catnip on traders’ Meow Mix. But S&P 500 futures retreated 20 points in the wake of the BLS report. We will have to wait and see how the numbers marinate over the weekend before markets reopen on Monday.
Negative Earnings or Low-Bar Theatrics?
Meanwhile, earnings season is set to open with expectations of negative average EPS for the S&P 500. Now, a big chunk of the gloom derives from just one sector, energy. According to FactSet, energy companies are poised to see EPS declines of 64%, with the pain shared among exploration & production names and service & equipment providers alike. But the 4.6% overall projected EPS decline is not from energy alone; six of the ten major sectors are expected to register in the red. Positive EPS growth is expected only in four sectors: healthcare (leading the way with 10.8% projected growth), consumer discretionary, industrials and financials.
The key theme of our Annual Market Outlook this past January was the importance of earnings as a leash on stock prices after three years of a robust multiple expansion rally. That leash seems to be giving large cap US stocks little roaming room on the upside, and a negative earnings quarter is unlikely to be of much help. However, we should be mindful of the theatrical element to the quarterly earnings event. At the beginning of this year, the consensus outlook for 1Q2015 EPS growth was 4.2% year-on-year. So the consensus has ratcheted down by 8.8% from then to now. That may be a sufficiently low bar for companies to do what they do best: exceed diminished expectations.
There is some evidence of a sector rotation at hand. Healthcare and even more so technology stocks, lately solid outperformers, have taken some hits in the past couple weeks; meanwhile the long-suffering energy sector seems to be finding a floor. In fact XLE, the SPDR ETF, has outperformed healthcare proxy XLV over the past 30 days. It may be a good time to add a bit to underweight energy exposures. But we are not convinced a full-blown rotation is at hand; rather, we are more inclined to look beyond generic sectors or geographies to names with the right mix of growth, profitability and asset quality as we head into choppy waters.