As rebounds in corporate profits go, recent history is probably about as good as it gets. That’s no surprise, considering that the hammering of corporate America just prior to the rebound was no less extraordinary. The implication: the best days are behind us. That doesn’t mean that corporate profits are destined for trouble, but recent history delivered a backdrop of nirvana for the stock market. If something less, and perhaps considerably less is coming, so too are attitude adjustments. The question is whether the crowd’s expectatiions are fully and fairly adjusted?
In 2008’s fourth quarter, after-tax corporate profits (seasonally adjusted, annualized) dropped by a crushing 34% vs. the previous quarter, according to data from the St. Louis Fed. Fast forward to this year’s first quarter and corporate profits posted a rebound of 70% of that cyclical low. As the chart below suggests, that’s the gold standard for bull markets for the bottom line.
And if we compare quarterly corporate profits on a year-over-year percentage-change basis, the trend of late also looks spectacular relative to history.
But now what? Optimism isn’t dead on the corporate-profits front, according to some analysts. “As long as we don’t fall into another recession, it’s a good time to make money,” Larry Hatheway, an economist at UBS, tells the Washington Post. “We’re able to squeeze more profits out of sales than we were twenty or thirty years ago.”
Maybe, but the market’s not quite sure if the best of times have passed. “Second-quarter corporate profits have gotten off to a robust start, but the stock market has moved lower and shown little pep,” writes Dave Kansas in The Wall Street Journal. “On top of that, various sentiment indicators, ranging from consumer confidence to investors’ view of the stock market, have slid sharply.” He goes on to note:
According to the American Association of Individual Investors, bearish sentiment is at its highest level since 1987, when such record-keeping began.
So, why such a sharp disconnect between profits and performance? There are two things in play. One is an old Wall Street saw: Buy on the Rumor, Sell on the News. In simple terms, this means that traders will buy in anticipation of an event, such as quarterly-profit news, and then sell when that news comes out. The fundamental underpinning of this truism is that markets anticipate and look ahead more than they react to events when they occur.
That leads nicely into the second issue: Quarterly reports are indeed about the past. They are a reflection of what took place over a three-month period that ended some weeks before the report comes out.
This year’s second-quarter earnings results so far have delivered better-than-expected results, reports Don Miller of Money Morning, but it hasn’t spurred much new equity investing overall. He continues:
Some 10% of S&P 500 companies reported earnings last week, and results were actually a good deal better than the market reaction would lead you to believe. Companies beat earnings per share estimates by nearly 11% on average.
With the recent volatility, the commentary coming out of talking heads has been that investors are focusing on revenue rather than bottom-line earnings, perhaps because of the link between companies’ sales and the economy. If revenue is down because consumers aren’t spending, that’s a sign that the economy will remain weak.
But the “weak revenue” argument is misguided, as 73% of companies this earnings season have beaten revenue estimates, which is at the top end of the historical range and well above the long-term average of 62%, according to [Bespoke Investment Group].
The S&P 500 has advanced a slim 1.5% since the first second-quarter earnings report hit the Street, advises Kelly Evans of The Wall Street Journal. Why? One possibility is the Fed’s emphasis on the economic uncertainty of late. “For every upside surprise in corporate earnings, it seems there’s a disappointing piece of economic data.”
It doesn’t help that earnings comparisons are destined to moderate. Maybe not in this quarter, but soon. That’s not a death sentence. The mother of all earnings rebounds must return to normal and so the earnings party is headed for calmer, gentler days. That’s not a problem in and of itself. But until there’s more optimism on the economic front, the macro-adjusted reality for corporate earnings growth isn’t likely to inspire the crowd.