Main Street trouncing Wall Street in game of earnings guidance

Bloomberg

Stock investors have stopped heeding the increasingly skeptical message of Wall Street earnings forecasters. Maybe everyone should.
Pessimism of any type is starting to look like a misjudgment in the stock market of 2019, a year with a shot at becoming one of the best in decades. The S&P 500 has surged for four straight weeks, closing at a record three of the last five days.
All as company analysts keep slashing 2020 estimates.
It’s a weird divergence: stocks up, earnings estimates down. Don’t corporate profits call the market’s tune? The issue is whose expectations you believe. While a reduction in analyst projections is to some degree natural at this time of year, forecasts from corporate America have quietly started to improve. And the latter is the trend it has paid to follow.
“We’ve gone from earnings being too high and needing to come down to earnings probably being too low and needing to come up,” said Mark Hackett, chief of investment research at Nationwide Funds Group, which oversees $65 billion. “The tone of management teams in their quarterly communications are much more positive.”
For anyone afraid of a repeat of last year, when plummeting earnings projections by analysts preceded a market meltdown, the last few weeks have been a relief. With the S&P 500 up 22% in 2019, skepticism over the advance runs deep. Especially if you believe next year’s earnings estimates are too high. But a dose of confidence from company management is soothing bulls.
Corporate guidance has grown steadily more optimistic since the summer, Bloomberg data show. The share of companies that have issued outlooks higher than consensus estimates over the last 12 weeks now stands near 45%, the highest since January.
According to BMO Capital Markets, stocks almost always go up in periods following bottoms in corporate guidance. Twelve months after a trough, the S&P 500 gained 14% on average, according to strategists led by Brian Belski. As it stands, the benchmark is up 5% from the turn in guidance seven months ago.
“Companies are not panicking yet, which leads us to believe any potential EPS estimate drawdown will not be as severe as feared,” the strategists wrote. “In fact, guidance levels have been steadily improving since early summer, despite the perception that CFOs are only signalling bad news.”
Positive guidance hasn’t kept analysts from taking a knife to their own profit estimates. Since the end of August, earnings-per-share forecasts for companies in the S&P 500 have fallen from $181 to $177.70, a decline of about 2%, Bloomberg Intelligence data show. That’s more than three times the degradation seen last year over the same period.
But even after all those downgrades, analysts still expect profits to increase 9.3% next year, though that predicted rate is likely to shrink further. Jonathan Golub, Credit Suisse’s chief US equity strategist, has estimated the historical trend alone would result in a drop to 5%. Nationwide’s Hackett envisions an environment in which profit growth ends up exceeding that.
A weaker dollar and less margin compression could help reported earnings for 2020 grow 8%, he says. For investors assuming the historic drift will prevail, that would come as a positive surprise.
Where to take your cues from, then? One kink in the argument for turning exceedingly optimistic is that while guidance is rising, it’s doing so among a smaller contingent of firms. More than usual are saying nothing about the future. “Expectations for 2020 remain sparse,” writes Bloomberg Intelligence’s Peter Chung.
“The problem is that at the moment everyone is in a wait-and-see because the trade war is so important for all the companies,” said Didier Anthamatten, senior portfolio manager at Unigestion.