Opening Statement from the April 2015 Intelligent Investor (Part 1)
First published on April 8, 2015 for subscribers to the Intelligent Investor
Alcoa marked the beginning of Q1 earnings season today. With little surprise, Alcoa beat earnings consensus but came up a bit short on revenues. While management boosted estimates for aluminum demand from 7% to 9% in 2015, we do not believe it will lead to further upside if the strength in the dollar persists. Although we believe Alcoa is well-managed, we believe the risk of further downside from current levels is significant due to sector weakness.
The US stock market has traded largely as expected. From last month you will recall we discussed a trading range for the Dow Jones between 17,000 to 18,000, give or take 100 points.
In the March 2015 Market Forecasting presentation, we went into more detail and concluded that active investors should focus on the bullish end of the support at around 17,300 or 17,400. Although the Dow has not yet declined to this level, it has made several trips to the 17,500-17,600 region.
As we move into 2015 quarterly earnings investors are likely to become more sensitive to earnings, revenue revisions, shortfalls and downward guidance than in the past couple of years (once interest rates finally begin a trend of increases, we expect this sensitivity to pick up further). Thus, we expect market volatility to increase in coming weeks/months, assuming a sufficient number of firms surprise analysts.
It is always important to remember that expectations are EVERYTHING when it comes to earnings and forward guidance. Generally speaking, as long as companies gradually guide earnings estimates downward, stocks usually do not get hit hard because analysts and investors are better able to wean off of previous estimates.
It’s the unexpected earnings or revenue misses that take analysts and investors by surprise. This is what leads to a collapse in share price. Often, forward guidance can be as influential on the share price as earnings.
It is important to remind readers of these realities because both analysts and investors have recently become more cognizant of the growing weakness in the U.S. economy. As well, the cumulative effects of a strong dollar are beginning to weigh on many firms that derive a good deal of earnings internationally.
As previously discussed, firms in the S&P 500 with greater global exposure are expected to report weaker earnings due to the relative weakness of the global economy versus the US economy.
Although the deceleration in earnings growth has eased up in recent weeks (from -4.8% in early March), Q1 earnings is expected decline by 2.8% relative to Q1 2014. Despite the improvement from March, if the most recent estimate is met, it would be the largest quarterly earnings decline since Q3 2009.
We have been warning about earnings weakness ever since fall of 2014, so this is by no means a surprise to us. The real question is how earnings will fare in the second half of 2015.
It should be no surprise to anyone that the sector with the greatest decline in earnings for Q1 is Energy. Thus, the next question we seek to answer is how earnings look if Energy firms are removed from the S&P 500. This is where things begin to look a bit more optimistic.
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