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(Bloomberg) — High on the list of things bulls dread this earnings season is that it become the scene of a big downward cut in next year’s estimates. It happened last year, helping foment the worst fourth quarter of the bull market. And though it’s very early, it’s happening now.
Despite a week of decent results, analysts last week chopped estimates for combined S&P 500 earnings in 2020 by almost $1, to $178.40 a share. Down 0.5%, the decline was the biggest for any week since January, data compiled by Bloomberg showed.
To be sure, analysts almost always over-estimate future earnings and lower their forecasts as a period draws near. And S&P 500 profits are still projected to expand 10% in 2020, compared with 1.9% this year. But amid memories of last year’s spectacle — in which forecasts peaked in September and then started an 8% slump — bulls need next year’s estimates to stand up.
“For the market to meaningfully take a step to the upside, investors need to have greater conviction that you’re going to get high single digit or better earnings growth,” said Jeremy Zirin, head of Americas equities at UBS Global Wealth Management. “Markets have to get comfortable that you’re going to see a re-acceleration of earnings growth.”
Two weeks into this reporting season, investors are already showing heightened sensitivity to instances where companies fail to live up to Wall Street’s earnings and sales expectations.
Among S&P 500 companies that have announced results, 81% beat earnings estimates, a near-record pace. For those that didn’t, retribution has been swift. Companies that missed on both sales and revenue saw their shares trail the market by 3.9 percentage points in first-day reactions, compared to the historical average of 2.4 points, data compiled by Bank of America (NYSE:) showed.
“This may suggest that investors are not yet confident enough in forward-looking outlooks to look through 3Q misses,” BofA strategists led by Savita Subramanian wrote in a note.
While much has changed since a year ago, most notably the orientation of the Federal Reserve toward interest rates, investors are aware that earnings sentiment started to turn south right before the market meltdown.
DataTrek Research’s co-founder Nick Colas is among those who think analysts’ estimates have to come down a lot from current levels. Sales growth will be subdued, coming in between 3% and 4%, he estimated. Margin pressures — like higher wages and input costs — will “eat up” all those gains, making for 2020 profits that “essentially mirror” this year’s, at $163 a share, he wrote to clients. That would mean virtually no growth.
For now, that risk doesn’t seem to be registering with investors, thanks to a global effort from central banks to spur growth. To Mike Wilson, chief U.S. equity strategist with Morgan Stanley (NYSE:), it’s only a matter of time for the reality to sink in. His model on earnings revisions suggested the S&P 500 would have been flat in the past 12 months, as opposed to an actual 6% increase.
“This reflects the very aggressive shift in monetary policy recently by the Fed and other central banks — i.e. that policy change is priced,” Wilson wrote in a note. “However, once the market gets past the initial relief it will have to contend with the deteriorating fundamentals.”
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