Fourth-quarter earnings season starts soon, but everyone is focused on 2017 guidance. The big problem: no one knows how to model the Trump rally.
Here's the good news: fewer companies are guiding down for the fourth quarter.
Now the bad news: what we care about is 2017 guidance, and there's a good chance that most companies will not be doing any dramatic fist pumps about earnings in the new year.
Here's Lindsey Bell, CFRA's Investment Strategist and chief wizard of earnings, on what she thinks will happen: "We expect guidance will be unlikely to move higher in the near term and could even be reduced from the current estimate... disappointing investors and potentially causing a pullback or pause in the market."
Huh? How could that be? All this gushing optimism is for nought, at least for the time being?
The question is, how much will earnings improve? How much will this magical potion of tax cuts/less regulation/fiscal stimulus really impact earnings?
We don't know and that's why analysts have been reluctant to raise 2017 earnings estimates. Current estimates for earnings in 2017 are at roughly $131, about an 11 percent improvement over 2016, but essentially unchanged for the past several months.
That's an important point: no one is raising 2017 estimates, at least not yet.
More importantly, because the stock market has risen roughly 6 percent since the election, but 2017 earnings estimates have not risen. Stock multiples have expanded, from roughly 16 times 2017 earnings for the S&P 500 to a little over 17 times. This is high by historical standards, but optimists insist it is justified because earnings will be improving later in the year.
Maybe. There's plenty of back-of-the-envelope guesses, just not many facts. Leon Cooperman, on our air Thursday, noted that current 2017 earnings for the S&P 500 is at $131 or so but "We could see earnings at $140" if the full package of tax cuts and infrastructure come through.
But there's plenty of signs that corporations are going to be very cautious in their 2017 guidance. Caterpillar fired the first shot across the bow on Dec. 1. The stock had risen 14 percent in the three weeks since the election on hopes that it would be a big beneficiary of any infrastructure spending program. Caterpillar attempted to tamp down any such expectations, saying earnings estimates of $3.25 a share in 2017 were "too optimistic considering expected headwinds." Analyst have since taken the company's 2017 estimates down to $3.09, according to Factset.
David Aurelio, who analyzes earnings at Thomson Reuters, said that other companies may copy this warning in the coming weeks: "I suspect...that companies may use this as an excuse to lower expectations without raising red flags in 2017 because I haven't seen policy changes broadly reflected in estimates."
Some sectors have good reason to be cautious. Take the health care sector: no one knows how the battle to replace Obamacare is going to play out. Here's HMO provider Centene, which issued cautious guidance for 2017 on Dec. 16: "As described in our press release, we have reduced our margin expectations for the Health Insurance Marketplace business in 2017 reflecting a wider range of possible outcomes due to the uncertainty of final membership enrollment and utilization as a result of the outcome of the Presidential election."
Not even Centene knows how this is going to play out.
There's another reason you're likely to see companies avoid being overly optimistic: they've been burned before. Many times.
Here's industrial giant Eaton, on their Nov. 1 conference call: "I think we and so many other industrial companies over the last four years, let's be candid, we got it wrong. We were too optimistic around the market outlook and we assumed that things were going to get better. Why? Because things always get better at some point, and so we went out on these limbs and called turns that ultimately didn't materialize, this year included."
Ouch! A rare candid admission!
What's all this reticence mean for the markets going into the Trump inaugural? The Trump rally has stalled out — no one is selling, but it's been tough pushing stocks up for the past three weeks. Leadership is lacking. The markets are waiting for some new catalyst, and strong earnings guidance would clearly do the trick.
Here's the problem: stocks typically try to discount earnings out six months to a year. But if earnings are not going to match expectations this year, than you are essentially arguing that stocks should be priced on earnings even further out. That is a tougher call, as Nick Raich from the Earnings Scout points out to me: "The further out you have to go to justify prices, the more speculative the market is. If you give 2017 a pass and just say, let's focus on 2018 and 2019, which are one to two years out, you are in a very speculative market."
Now you see why traders are so hungry for details they can plug into an earnings model? It could be a long winter for bulls who want to keep the rally going.