Earnings season may not give investors that warm and fuzzy feeling this quarter.
For the first time in six years, earnings are in a real decline, expected to be negative with a 2.9 percent drop in net income, according to Thomson Reuters. That comes as price-to-earnings ratios, or valuations, are at the highest levels in a decade, and the question is whether those are weak earnings already priced in to the market.
The first big wave of earnings reports is expected in the week ahead, with major banks and financials, like J.P. Morgan, Wells Fargo and American Express, and other blue chips like Intel and Johnson & Johnson.
Quarter after quarter, earnings have topped Wall Street forecasts, beating by a wide margin of 70 percent plus, and that's still what many strategists expect, even if profits fall below last year's level.
"I expect the market to remain largely range bound until we get further into the earnings season," said UBS equities strategist Julian Emanuel. His theory is that companies will beat sharply reduced guidance, clearing the way for the market to move ahead.
Wall Street's economists expect the slow-growing first quarter to give way to a spring rebound, and many analysts expect the earnings decline to end in the second half.
"The problem comes if the economic numbers don't pick up over the next month or two as you come out of earnings season, assuming the market has rallied in the interim because we're about to look through the first quarter as we expect," Emanuel said. "If the economy doesn't pick up, you have to confront the idea that the entire year could be a down year for earnings, and while that's not going to kill the market, that could make later spring into early summer into a more volatile period."
Stocks recently have struggled against a stronger dollar, but this past week was also good for the greenback. The dollar index gained 1.8 percent for the week to just over 99.30, as of the stock market close on Friday.
Brown Brothers Harriman chief currency strategist Marc Chandler said technically the dollar looks set to continue its advance. If the dollar index regains 100.39, it's next target would be 102.25, he said.
"This is probably one of the best weeks for the dollar in several years," he said, noting the dollar's gain came after it declined on March's weak jobs report on Good Friday. "We did have some widening of interest rates, but it was more of a function of no follow-through from last Friday…. We had a decent JOLTs number and jobless claims are at cycle lows, suggesting that people not get too excited about the slowing economy."
Besides earnings, there are a number of important economic reports, including retail sales for March on Tuesday and industrial production on Wednesday. There are also producer inflation and consumer inflation data on Tuesday and Friday.
A handful of Fed officials are also speaking, most importantly Fed Vice Chairman Stanley Fischer, who will attend the IMF spring meeting Wednesday and Thursday. The European Central Bank also meets Wednesday, and it is not expected to take action but will discuss its quantitative easing program.
Economic data has taken on even more importance after the Fed last month said it is likely to raise rates this year, and its decision will be based on the performance of the economy.
"Retail sales should be an up number after a couple months of down numbers," said Chandler. "That'll help give the idea that the U.S. consumer hasn't dried up and gone away."
But it is earnings news the stock market has been most anticipating. The decline in profitability comes as the S&P 500 has become ever pricier, now with a trailing price-to-earnings ratio of 17.3. That's the highest level since 2005, aside from 17.5 in February of this year, according to FactSet data.
"I think you'll continue to see choppy (market) conditions. I wouldn't say I'm super cautious, but I think with valuations this elevated, I know there's a lot of pessimism around earnings and I have a hard time saying it's priced in," said Lori Calvasina, chief U.S. equity strategist at Credit Suisse.
The hit to earnings has largely been in the energy sector, due to the steep drop in oil prices. But the strong dollar has also been a factor that is expected to bite into profits of multinationals who make revenues overseas.
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Goldman Sachs strategists expect a first-quarter revenue decline of 3 percent for the S&P 500, but a gain of 4 percent if energy is not included. In a note, the strategists said the near 50 percent decline in oil prices shaved six percentage points off of revenues growth, while the dollar's 11 percent gain likely took off only three points.
Even as the earnings recession has been much discussed, Calvasina said investors are going into the quarter with a skittishness about valuations. "They're (economists) making the case we're going to slow in the short term and reaccelerate in the back half. That's kind of consensus expectations. I would say people are using that to justify the high multiple, but I do think people are worried about valuation," she said.
Calvasina said while the S&P p/e is 18 on future earnings, her valuations model is at a higher level than it was just before the financial crisis, though not as high as during the tech bubble. It was at 1.59 standard deviations above the 30-year average in March, and it was 1.88 during the tech bubble. Her model combines trailing and forward price-to-earnings ratios, price-to-book and price-to-sales.
With the problem of valuations and wobbly earnings, Calvasina said corporate buybacks are one of the best catalysts remaining for the stock market.
General Electric Friday announced a $50 billion buyback, on par with the largest-ever buyback of the same size announced by Apple two years ago. According to Citigroup strategists, the S&P 500 has bought back $4 trillion of its stock in the past 10 years.
"The cash deployment theme is the thing we count as the big positive. We have been a little concerned that you might be in the final stages. You might be in the late innings…. This doesn't mean it has to stop. We've seen cash levels go down. Debt levels have gone up. You're starting to see a little more interest in M&A," Calvasina said.
The benefits have been twofold: Buybacks give companies smaller float and help on the earnings side, with a small share count boosting earnings per share.
"It has been a strong underpinning and you can't underestimate the positive of that," she said.
What to Watch
7:30 a.m.: NFIB small business survey
8:30 a.m.: Retail sales
8:30 a.m.: PPI
10 a.m.: Business inventories
8 p.m.: Minneapolis Fed President Narayana Kocherlakota
8:30 a.m.: Empire State survey
9 a.m.: St. Louis Fed President James Bullard
9:15 a.m.: Industrial production
10 a.m.: NAHB survey
10:40 a.m.: Fed Vice Chairman Stanley Fischer, moderating IMF panel
2 p.m.: Beige Book
4 p.m.: TIC data
Earnings: BlackRock, Citigroup, Goldman Sachs, Blackstone, American Express, Schlumberger, Celanese, Crown Holdings, UnitedHealth, Taiwan Semiconductor, Philip Morris, First Republic Bank, KeyCorp, Mattel, Sherwin-Williams, Sonoco Products, PPG Industries, WW Grainger
8:30 a.m.: Initial claims
8:30 a.m.: Housing starts
10 a.m.: Philadelphia Fed survey
1 p.m.: Atlanta Fed President Dennis Lockhart
1:10 p.m.: Cleveland Fed President Loretta Mester
1:30 p.m.: Boston Fed President Eric Rosengren
3 p.m.: Fed Vice Chairman Fischer on inflation at IMF spring meeting
8:30 a.m.: CPI
10 a.m.: Consumer sentiment