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Tough times ahead for US earnings

US earnings season does not promise to be particularly pleasant reading for investors. Low oil prices will hit energy firms, and then there’s the strong US dollar, which will not have made life easy for American exporters. 

US flag
Source: Bloomberg

Over the past three months, expectations have become increasingly negative. Analysts now expect the upcoming earnings season to reveal a fourth consecutive quarterly decline in income, the first time that this has happened since the financial crisis.

FactSet expects profits at S&P 500 companies to have fallen by 8.5% from the previous quarter, a remarkable drop from the 0.8% growth in earnings that had been forecast at the start of the year. Reuters is even more negative, with the overall drop for each sector shown below:

USE
Source: Reuters

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USE
Source: Reuters

Of course, much of this is down to energy (and the graph is correct – the Reuters forecast is for a 99% drop in earnings for the sector). If energy is taken out then the forecast is still for a drop of 1.8%. This comes after a remarkable rally in equity prices that has many wondering whether the rangebound nature of markets from mid-2015 to February 2016 is finally at an end, or whether the start of a new big correction is upon us.

Even Apple, once the darling of the stock market and a strong performer in years past, is not expected to do well, as earnings drop 14% compared to the first three months of last year. Currently, the broader US market trades at 17 times earnings, which does not suggest a ‘value’ proposition. Instead, investors are looking for earnings growth, and only Consumer Discretionary, Health Care and Telecoms are expected to provide this.

Even here, the news is not all good. AT&T is going to be the largest contributor in telecoms, and if that is removed then growth drops to a measly 1.7%, although it is still expected to be positive, unlike most sectors. In consumer discretionary, department stores are expected to have a tough time of it, with sales falling around 37% — this is offset by an 80% jump in internet retailer earnings and a 50% rise in income for car makers.

Finally, there is the issue of stock buybacks. Companies have been furiously buying up their own stock, to help inflate share prices and boost EPS figures. Evercore analysts have reported that around 76% of the S&P 500 bought back stock in the final three months of last year. Now, that is on the wane, removing one key tailwind for equities that has yet to be replaced by inflows into investment funds.

It could be a difficult quarter, especially for banks, which have seen their earnings hit by stubbornly low interest rates. The jury is still out on whether the market is poised to break higher or roll over, and the next few weeks could be decisive. 

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