First quarter earnings are going to be a roller coaster of good and bad news. The good news: Earnings are expected to be up roughly 6% in the first quarter and estimates are about little changed since the start of the year. The bad news: There is such a wide outcome in the key variables that will influence the second quarter guidance (inflation, oil, the Fed, Ukraine) that there is not a lot of confidence in future earnings projections. Earnings have held up remarkably well You'd think with rising rising rates, an aggressive Fed, oil over $100, persistent supply chain disruptions, and a war in Ukraine, the markets would be a mess. Yet the S & P 500 is down less than 4% for the year, and the market is in an uptrend, rallying 10% since the March 8th low. That's because the issues that really moved markets — inflation and Ukraine — are a little less dire, while earnings are holding up well. "Markets are expecting a great Q1 earnings season," Nicholas Colas from DataTrek said in a recent note to clients. But others note that analysts have been reluctant to raise estimates, even in the face of a strong economy. Noting that first quarter earnings estimates are below those of the fourth quarter, JP Morgan's Marko Kolanovic said, "The hurdle for the coming earnings reporting season, which kicks off in the US in about two weeks, seems rather low." 2022 earnings estimates have been relatively steady. They are slightly lower for the first quarter compared to the beginning of the year, but higher for the following three quarters. 2022 earnings trends (vs. Jan. 1) Q1: up 6.4% (lower) Q2: up 6.7% (higher) Q3: up 10.5% (higher) Q4: up 10.3% (higher) 2022: up 8.8% (higher) Source: Refinitiv Earnings winners and losers There's always winners and losers, but the first quarter earnings estimates have an unusually wide dispersion. Sectors seeing notable earnings estimates increase during the quarter: energy. With oil prices way up, this was the big sector winner for the quarter. Expectations were already high going into the quarter, with earnings expected to be up 165% from the same period last year, but they are now expected to be up 228%, according to Factset. Sectors seeing notable earnings estimates decrease during the quarter: airlines, casinos, hotels. No surprise here as travelers cancelled plans as Covid cases ramped up in January. Retailers are also seeing declining estimates partly on supply chain issues. Two megacap stocks also saw estimates come down this quarter: Amazon and Meta. Early reporters: a mixed bag A small group of roughly 13 companies (Autozone, FedEx, Costco, Lennar, Oracle, and a few others) report their earnings early, often because their quarters end in the month before. They are closely watched as an "early warning sign" for the rest of corporate America. The results are mixed. Of the 13 that have reported so far, 71% have beaten estimates by an average of 11%. This is only slightly worse than they reported last season, when 69% beat by 14%. While slightly worse than expected, it still "may be better than many feared it would be," Nick Raich, who tracks corporate earnings at Earnings Scout, told me. Second quarter guidance is what matters The fact that analysts have done little to change their estimates since the start of the year is prompting some concern. "Our research indicates EPS expectations will need to be reduced in the weeks ahead to reflect all the negative variables," Raich said in a recent note to clients, citing rising interest rates, inflation, persistent supply chain disruptions and increased geopolitical risks. "Expectations appear way too high," he said. "As always, sell-side analysts are waiting for companies to report to get their guidance before they make their negative EPS estimate revisions." Stocks vs. bonds: who's right? The biggest concern for stocks is a growth scare that would cause earnings estimates to drop notably. Bears are citing the bond market, which in their eyes is flashing concerns about a growth scare or even a recession as the yield curve flattens. The stock market, on the other hand, seems to believe that growth will remain strong. Which is right? For the moment, analysts are ignoring the potential for a growth slowdown. Partly, this is because analysts have trouble looking out more than one or two quarters. Strategists, on the other hand, are paid to be a bit longer term, and here there is a wide diversity of opinions. Michael Wilson at Morgan Stanley noted that there is a "heightened risk to earnings growth from rising risk of recession next year, cost pressures, payback in demand, and a war that has structurally increased the price of food and energy--i.e., a tax on the consumer." Still, for all the worries that the Fed is going to squash growth, the ultimate mover may simply be oil and the outcome of the Ukraine crisis. Nick Colas says that the action this quarter indicates that geopolitics and oil prices trump the perception of future Federal Reserve hikes. "As for what captures the market's attention in Q2, we think the 1-word answer is 'earnings'," Colas said. As long as Russia-Ukraine does not cause another oil price spike, the market only has to worry about Fed policy (which it now assumes will be aggressive) and corporate earnings power." "That's not a bad setup as we start the second quarter."
Packages move along a conveyor at an Amazon fulfillment center on Cyber Monday in Robbinsville, New Jersey, Nov. 29, 2021.
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First quarter earnings are going to be a roller coaster of good and bad news.