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How is Earnings Season Shaping Up?

The last month was filled with fourth quarter earnings reports. So far, several sectors’ earnings have been disappointing as profits have been hurt by lower oil prices, a rising U.S. dollar, and outsized company pension charges — particularly with telecom companies.
The energy sector earnings came up $0.93 short of estimates due to falling oil prices. This sector has the largest decline in earnings of all sectors, totaling about 21% (source: FactSet). Coal and Consumable Fuels was hit the hardest with a 54% drop in earnings while Oil and Gas Drilling only fell 8%. Two energy sectors are reporting positive growth: Equipment and Services (+22%), and Refining and Marketing (+19%).
Energy is a significant drag on fourth quarter growth for S&P 500 companies. Overall, the blended growth rate for the group is expected to be 3.1%. Excluding energy, this rate would rise to 6.1%, per FactSet’s calculations.
S&P 500 operating earnings may have also been reduced by as much as $1.06 relative due to a stronger dollar, which lowers the value of U.S. companies’ international revenues when translated back into U.S. dollars. As much as 40% of the S&P 500’s revenue comes from overseas.
Companies have also been forced to contribute more to their pension funds after low long-term interest rates substantially increased the value of their pension liabilities, subtracting as much as $1.19 from earnings. The nonprofit Society of Actuaries also recently revised its mortality tables for the first time in fifteen years and estimates that the average retiree will live about two years longer. When pension beneficiaries live longer, companies have to kick in more payments to their pension plans.
We’ve also seen 85% of companies issuing negative earnings guidance for the first quarter of this year. Keep in mind, however, that the normal rate for negative guidance is about 68%, which enables managers to be “heroes” when their results beat overly pessimistic estimates.
The earnings reports and first quarter projections, as well as new worries about Greece, caused volatility and a move down in January, but stocks have recovered to new highs in February. What is the cause of this seeming disconnect?
Because the US is still a net user of energy and cheaper oil will benefit both companies that use oil as an input and consumers who now have an average of $2,000 per year more in their pockets. Cheaper imports caused by the stronger dollar will also help the consumer.
There is a lag between changing consumer behavior and companies’ positive earnings revisions. The market is starting to realize that AND is anticipating quantitative easing measures in Europe to flow to US shores.
Greece is still a concern, but the markets are much less worried than they were a few years ago about a Greek contagion spreading to Italy, France and Spain. If Greece were to default on some of its debt or take steps to leave the Eurozone, the markets believe the effects will be much more isolated thanks to new powers of the European Central Bank to facilitate liquidity.
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