Earnings Season Is Underway

• The Financial Times – Upbeat start to US earnings seasonCorporate America issued a string of quarterly earnings results on Tuesday that exceeded Wall Street’s expectations, reflecting how big US companies have cut costs faster than revenues have fallen. However, stocks fell as investors focused on the lack of top-line improvement, with the S&P 500 index slipping 0.6 per cent to close at 1,091.06. “A lot of the numbers are not due to revenues but due to cost-cutting, so the market has sold off slightly, regardless of the fact that the results have been good,” said Doreen Mogavero, a floor trader on the New York Stock Exchange.

Comment

• The Wall Street Journal – Profits Poised to Surprise Again Even a Bona Fide Bear Sees Figures Beating Forecasts for 3rd Quarter in a Row

  Earnings in the first two quarters of the year that beat expectations helped propel the market’s recovery, and the prospect of a repeat has even some bears wondering if they have been too pessimistic. Morgan Stanley investment strategist Jason Todd, one of the few remaining bears on Wall Street, told clients last week that the stock market is looking stronger than he thought and won’t tumble, as he has been predicting, at least through the end of the year. “We think equities will now trade above” his previous target for this year, Mr. Todd said in his report, “in large part because earnings will be higher than we previously anticipated.” Until now, Mr. Todd had been predicting the market would fall 14% from today’s level by the end of the year. Now he is telling clients that the Standard & Poor’s 500-stock index — which is up 54% from its March 9 low — is likely to rise marginally between now and year’s end and could be up as much as 15% before it gets into trouble.

Comment

The answer lies in when the estimates are taken. The study above is based on the last estimate before earnings are released. We have likened this to the point spread in a football game getting reset with 1 minute left to play.

What this proves is investor relation departments have become very good at gaming the system. They do everything in their power to make sure the headlines say their company beat earnings estimates. But, beating the last estimate has no economic value. To gain any insight on the economy based on earnings estimates one must take a longer-term view.

We detailed this longer-term view on September 29:

The next chart uses Bloomberg data for bottom-up forecasts. By mixing IBES and Bloomberg forecasts, we risk comparing apples to oranges. But, if the surveys are done properly they are both surveying the same people and should offer a very similar data set.

As highlighted on the chart below, the current forecasting error is now near 100%, more than three times the largest error seen from 1985 to 2002. No other period has ever come close to the current period.

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Conclusion

In actuality, earnings forecasts are worse now than at any time in human history. As the chart below shows, the decline in earnings in the last year was worse than any decline in the last 140 years ( no typo). The data comes from Robert Shiller who got it by way of the Cowles Commission.

Do you recall anyone forecasting a biblical collapse in earnings? We do not. In fact, Dr. Jeremy Siegel set records in tortured logic to explain this was not happening last February.

Rather than writing about rebounding earnings, a more interesting story might look into why consensus estimates have been so horribly wrong lately. Do the forecasters understand the degree to which they missed, and have they changed their methodology at all to avoid a similar fate should this happen again in the future? Only when these questions are answered should anyone pay attention to these highly inaccurate guesses.

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