Investors can expect corporations to beat lowered estimates by solid margins this earnings season, but it might not deliver a fillip to the overall stock market, according to analysts at Bank of America Merrill Lynch.
Consensus estimates for first-quarter earnings per share on the S&P 500 is for a 9% year-over-year decline—after a 9% downward revision—and would mark the third consecutive drop, according to FactSet.
The team of analysts, led by Savita Subramanian, market strategist at Bank of America Merrill Lynch BAC, +0.23% expect companies to beat estimates by 4 percentage points—mostly due to a decline in crude prices that was less severe in the first quarter of 2016 than during the same period in 2015.
For example, crude prices declined nearly 11% in the first three months of 2015, compared with a 3.5% gain for the commodity in 2016 over the same stretch, according to FactSet data. Crude has lost more than two-thirds of its value since its peak in 2014 and that has walloped earnings for oil-and-gas companies.
Meanwhile, the dollar—another headwind for multinational companies—fell 4.1% in the first quarter of 2016, as measured by the U.S. ICE Dollar Index DXY, -0.34% compared with a climb of about 9% during the first three months of 2015.
Since the second quarter of 2015, companies based in the U.S. have regularly blamed the strong buck for weaker-than-expected earnings. Dollar strength can translate into weaker sales for U.S. companies when money is repatriated from a country with a weaker currency.
The greenback’s retrenchment may be why BAML is predicting that multinationals will outperform domestic companies:
|“. multinationals are seeing better estimate revision trends than purely domestic stocks for the first time since 2014, as well as better guidance trends. These stocks have outperformed the market by over 4 percentage points since the mid-February reversal, but after underperforming by nearly 35% over the past five years, there may be room for a bit of catch-up this earnings season.”|
But despite the alleviation of some of these pressures for corporations, even a healthy outperformance in earnings might not be sufficient to send the market higher in the short term, because overall economic and revenue growth remain sluggish.
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One reason for this is that many companies have laid off workers and restructured their businesses to grow their quarterly profits and have few levers left to pull to further juice earnings, especially if the domestic and global economies perform as poorly as economists are predicting.
|“…overall growth remains tepid and given the 13% rally off the February lows, much of the potential beat may already be reflected in stock prices”|
In fact, BAML economists’ forecast for the first-quarter GDP is a mere 0.2%, while they forecast about 2% growth for the whole year.
The lion’s share weakness in earnings will come from the energy sector, which is forecast to see an ugly quarterly loss of 3.8% compared with the same period last year which saw the sector post a profit of $12.9 billion, according to FactSet data.
For financials—the engine of the economy—profits are slated decline nearly 11%, according to FactSet data. The Federal Reserve’s reluctance to normalize benchmark interest rates due to concerns about the economy abroad has hobbled financial firms, which can collect richer returns when interest rates are higher.
Focusing on sectors that might outperform, Subramanian & Co. is recommending health-care and tech stocks, while proposing that investors shun energy and materials shares. BAML argues that companies with greater earnings and sales revisions and management guidance historically have been prone to underperform more sharply or offer better upside surprises. The following table gauges BAML’s preferred sector on a scale of 1 to 10, with 1 representing the most attractive sectors.