Companies Have Lowered Expectations Which May Be Good News for Stocks

Rodrigo Campos and Caroline Valetkevitch of Reuters have an interesting article which points out that companies have been tempering expectations over the past several weeks. But the lower guidance may actually be good for stocks.

S&P 500 earnings were expected to increase just 1.5 percent for the first quarter when earnings season began and the latest estimate stands at 1.1 percent. But investors and strategists say that earnings will more than likely look substantially better when the season comes to a close.

So far there have been 108 warnings for first-quarter results. The 4.5-to-1 negative-to-positive ratio is the seventh worst for any quarter since 1996. Yet four of the previous six of those dire warnings periods have been followed by quarterly gains in the S&P 500; the average gain for those four with gains is 6.68 percent while the average gain for all six periods is a much lower 0.6 percent.

A 6.68 percent gain this quarter would take the S&P 500 to 1,674 by the end of June, extending a rally that has already taken it to record highs.

A look at a greater sample shows the persistence of this pattern. Of the 20 quarters with the most negative ratios since 1996, the average gain in the S&P 500 in the following quarter was 2.3 percent. By comparison, the average move for all of the past 68 quarters dating back to 1996 is 1.7 percent.

It is in the best interest of companies to avoid disappointments. Warnings have outnumbered positive pre-announcements in all but five of those 68 quarters, and yet companies almost always report results above analysts’ expectations.

The last time earnings have fallen short of analysts’ forecast was the fourth quarter of 2008 was when the impact of the financial crisis was so sudden and severe that it took time for everyone to assess its depth.

In the last 16 quarters, in all but one, the analysts’ expectations at the beginning of earnings season have been exceeded by anywhere from one to 22 percentage points, with an average difference of 6.4 points.

On average, 63 percent of companies beat earnings estimates, according to Reuters data going back to 1994. Investors have come to anticipate this, and recent gains may be in part due to the belief that earnings, once again, will not be as dire as forecast.

Posted by on April 15th, 2013 at 12:39 pm


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