Earnings Results Are Flashing Warning for Stocks
Just two weeks into the first-quarter earnings season, a greater-than-usual number of companies have reported disappointing revenue results and tepid guidance, leading strategists to expect a more volatile time for stocks.
"That is for sure not a formula for success against a weak economic backdrop over the last two weeks," said Art Hogan, managing director at Lazard Capital Markets, of the latest trend in corporate results. "We'll find out more in the next two weeks when more heavyweights report, but it looks like we've set the table for a pullback. Stocks are already looking at the most negative week for the year."
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To date, just over one-fifth of S&P 500 companies have posted quarterly results, with 67 percent topping earnings expectations. Meanwhile, only 43 percent have beaten their revenue estimates, which is significantly lower than the average 62-percent rate, according to the latest data from Thomson Reuters.
"Earnings, I would argue are coming in better than expected," said Bill Stone, chief investment strategist at PNC Wealth Management. "Underneath the surface is something that's not quite so healthy. They're struggling on the top line, the revenue side. That is indicative of a global economy growing below trend."
Most recently, diversified manufacturing company Honeywell reported earnings that topped Wall Street estimates, while revenue fell short. Similarly on Thursday, tech giants Google and Microsoft beat profit expectations but missed on sales.
"It's an alarming rate of revenue misses. It's easy for companies to manipulate the bottom line, but harder to do so for the top line," said Christine Short, associate director at S&P Capital IQ. "Revenue is definitely something we've been keeping an eye on and companies have been cautious in their press releases, pointing to the uncertain economy."
In another troubling sign for the longer-term, Short noted that of the 18 companies that have so far provided guidance for the second quarter, the negative-to-positive ratio sits at 14:1, a stark contrast against the average ratio of 2:1, according to data from S&P Capital IQ.
"We hope that the ratio will even out [but] at the same time, this is not necessarily surprising because we knew that the first half of the year was going to be weak for companies," explained Short. "Europe has been a red flag—everyone thought 2013 was going to be the year of recovery for Europe and it turns out that it's not the case."
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General Electric slashed its profit growth estimate for its core industrial businesses Friday, citing weakness in Europe and sliding wind turbine sales. The conglomerate now expects industrial profit to rise by high single digits to double digits this year, down from an earlier forecast of double-digit growth. (GE was previously NBCUniversal's parent company.)
In addition, Short said recent signs of weaker-than-expected growth in China has been a "yellow flag" for nervous strategists.
(Read More: Has China's Economy Hit a 'Dead End'?)
"Guidance has been weak and that's never a good signal," said Gina Martin Adams, institutional equity strategist at Wells Fargo Securities. "All we care about is what's going to happen to forward momentum of earnings and it looks like momentum is going to stay negative and numbers are going to have to come down for future earnings."
According to Ryan Detrick, senior technical strategist at Schaffer's Investment Research, the S&P 500 has a greater chance of being negative by the end of the earnings season if it is negative in the week following Alcoa's earnings—which was the case this quarter. He said in those cases, history shows the index is only positive 36 percent of the time until "when Wal-Mart reports," which is typically around the end of earnings season.
"There's definitely some truth to the saying: 'Sell in May and go away,'" said Detrick. "The market's been looking for an excuse to sell off and earnings could be it. We saw a huge correction around this time last year and so there are also concerns from a seasonality perspective."