Wall Street strategists are forecasting 2012 S&P 500 EPS of $100-$105. After fairly good first quarter results, their estimates edged up toward $105, but macro deterioration has brought numbers down to around $103. My guess is that ultimately (i.e., next March) they end up at $100, driven lower by a severe recession in Europe, slowdowns in China and the U.S., hostile regulatory policy in the U.S., and a strong dollar.
According to the media, analysts expect a modest yr/yr gain in second quarter earnings, but many people have forgotten that the comparison is exceptionally easy because a year ago Bank of America had a huge write-down. Adjusted for that, Q2 earnings could be flat or down slightly. But the big issue is not the precise level of Q2 profits but how much analysts cut estimates forQ3. Corporate CEO’s are no better at forecasting the economy than anyone else, but their Q3 guidance will reflect orders through the middle of July, so in a rapidly weakening global economy their comments will contain a lot of “new news.” Is demand just softening, or is it collapsing? We’ll find out.
You can’t tell the players without a scorecard. Here’s what to focus on in Q2 results:
Negatives for Q2 Profits
Weak Wall Street results. Profits in this industry are impossible to forecast, so surprises can be big and drive the quarterly S&P EPS number up or down quite a bit. After decent Q1 2012 results, Wall Street’s profits were poor in Q2, and the Euro-crisis, the fiscal cliff, and slower U.S. growth mean business won’t improve in Q3. JPMorgan’s big (but how big?) trading loss is another negative. Key EPS reports: JP Morgan, Citigroup, Goldman Sachs, Morgan Stanley.
Weak oil prices are negative for overall profits. Oil service firms will be hurt by weak drilling activity in North America; key reports include Baker Hughes and Schlumberger. Like Wall Street firms, Big Oil’s profits are hard to forecast because there are so many moving parts (upstream results, refining margins, chemical earnings, etc.) Key reports: Chevron, ExxonMobil, Occidental Petroleum.
Recession in Europe has already lowered expectations for McDonalds, Nike, and Ford. With demand collapsing in parts of Europe, corporate commentary will be very interesting. Some important early results: Coca-Cola, Marriott, Intel, Google, Eaton, Honeywell, and United Technologies. Alcoa’s comments on global demand for aluminum (used in autos, aircraft, and gas turbines) are always useful.
Slowdown in China. Results of Alcoa, Coca-Cola, Intel, Yum Brands, Wynn, United Technologies, and Caterpillar are key.
Strong Dollar. The Fed’ s “trade-weighted” dollar index rose 5.6% yr/yr in Q2, much stronger than the 1.1% in Q1 and the most since Q3 2009. This is a negative for all multinational firms, because foreign revenue and profits translate into fewer dollar. Currency effects will also have a fairly big impact on Q3 guidance. Reports to watch: IBM, Johnson & Johnson, Coca-Cola, United Technologies and Mattel. (A strong dollar eventually will hurt exporters, but not for many months.) Foreign sales are about 32% of S&P 500 revenues, not 46% as The Wall Street Journal recently wrote, drawing on faulty research by Standard & Poor’s.
Positives in Q2 Profits
Domestic profits have good momentum (remember Q1 earnings season was good) and the U.S. economy continues to grow, albeit more slowly than we would like. The difference between monthly job creation of 80,000 and 150,000 is a big deal politically but not for corporate results. Companies have figured out how to prosper in a soft economy by keeping costs low, inventories lean, and capital spending in check. Although Q2 domestic results should be okay, the big question is how much business has softened recently. Key reports: Alcoa, Marriott, Harley Davidson, Grainger, Darden Restaurants, PPG, Fastenal, and domestic commercial banks (Wells Fargo, U.S. Bancorp, PNC). Pay particular attention to what the banks have to say about loan growth and credit quality.
Apple typically delivers a big upside surprise.
Share buy-backs. S&P says they have slowed recently, but with stock prices weak companies are getting a bigger bang for the buck. So declining share counts will drive some upside surprises. Analysts tend to be conservative on their share count assumptions, because they don’t want this hard-to-forecast variable to drive their models.
