Thursday, July 07, 2016

Bulls Set to Be Disappointed by US Earnings
Nicole Bullock and Adam Samson in New York
Financial Times

Investors anticipating a return of US profit growth may have to wait a bit longer.

The surprise vote last month by the UK to leave the EU — and the potential fallout for the US dollar, the global economy and interest rates — has cast doubt on whether those expectations will bear out.

”It is a twofold impact,” says Alan Gayle, director of asset allocation at RidgeWorth Investments.

“The event itself is likely to have a dampening effect on global trade and investors nervousness is driving up the dollar, so you have two factors that could hamper a return to profitability in the second half of the year.”

If expectations for the second quarter prove true, US companies will post their fifth straight year-over-year profit decline for the period — the worst stretch since the aftermath of the financial crisis. With the season set to get into full swing next week, analysts are forecasting a decline of 5.4 per cent, according to FactSet.

US multinationals, which make a significant portion of their money outside the US, have struggled with dollar strength for more than a year. Since the Brexit vote on June 23, the dollar is up about 2.7 per cent against a basket of other currencies while sterling has fallen 13 per cent versus the dollar.

Investors have long focused on projections for the second half of the year showing a rebound in profitability. That has supported the broad market with the S&P 500 up nearly 3 per cent so far this year and less than 2 per cent shy of the all-time high of 2,134.72 reached in May 2015.

”You can count on a continued US dollar rally, which has certainly paused in the last six months,” adds Oliver Pursche, chief executive officer at Bruderman Brothers. “At best it is now questionable [that earnings growth resumes in the second half of 2016]. If it does, it is hard to imagine anything better than 2-2.5 per cent. From an investment thesis, you need to, if you are in the US look for companies that predominantly do business within the US.”

For the second half of the year, analysts are forecasting a combined increase of 4 per cent in year over year profits for the S&P 500 with 0.8 per cent in the third quarter and 7.2 per cent in the fourth quarter.

John Butters, senior earnings analyst at FactSet, expects most analysts will wait to hear what companies have to say about the ramifications of Brexit when they report second-quarter earnings before making any potential changes to their forecasts.

Analysts also tend to be more sanguine about company results the farther into the future they are. Mr Butters says that, over the past five years, analysts have overestimated actual earnings growth by 3.8 percentage points as of this point in time. Applying that average to the current estimate suggests the earnings growth rate for the second half of the year would be just 0.2 per cent.

Some observers are more optimistic about growth in the second half.

Jim Paulsen, chief investment strategist at Wells Capital Management, notes that on a trade-weighted basis the dollar is essentially flat year over year.

“If anything, for a crisis, it’s been a very muted rush to safe-haven dollar response,” he says.

Mr Paulsen also argues that the rebound in oil prices alongside a forecasted rise in US economic growth in the second half will support aggregate earnings in the back half of the year.

“I think there are more and more companies that will be reporting positive earnings momentum,” he says.

While the price of US crude oil is down by about 4 per cent after the Brexit vote, it still remains above the $45 a barrel mark, and up by 80 per cent from its lows of the year.

Dan Suzuki, equity strategist at Bank of America Merrill Lynch, agrees that so far currency headwinds seem to abating for US companies, but cautions that the uncertain nature of the consequences surrounding Brexit “puts some risk over how fast and how much [earnings] growth will recover”.

The extent to which earnings disappointments later in the year can derail the stock market could depend on other factors as well. The decline in long-term interest rates has lent some support to US stocks in light of recent unexpected strength in the dollar, some said.

“It is a tug of war — lower earnings expectations on one side and lower rates on the other,” says Nicholas Colas, chief market strategist at Convergex. “It seems to be a very tight competition at the moment.”

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