EARNINGS RECESSION?

April 6th Weekly Market Update

Earnings season kicks off this week (April 6 – 10) with Alcoa set to report first quarter 2015 earnings on Wednesday, April 8. This earnings season has received a great deal of attention in recent weeks because it may produce the first year-over-year decline in S&P 500 operating earnings since the tail end of the financial crisis during the third quarter of 2009. We preview earnings season and highlight reasons not to fear a potential decline.

FLAT IS THE NEW UP
Earnings growth has stalled in early 2015 primarily due to low oil prices and a strong U.S. dollar. The Thomson Reuters–tracked consensus currently expects a 2.8% year-over-year decline in S&P 500 earnings for first quarter 2015,
compared with the 7% earnings gain produced in fourth quarter 2014. Should the S&P 500 produce the average upside surprise observed over the past four quarters (4%), then earnings may match the year-ago period or perhaps even
grow marginally. Given these significant drags — each with an estimated impact of 4 – 6% — we would expect this outcome to be well received by the market, should it occur. Revenue is expected to drop by a similar 2.3%.

Upside to earnings estimates could come from several places:
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-Low energy prices. Lower energy prices for consumers are like a tax cut that should help support earnings for the consumer sectors. Lower fuel costs also help lower transportation costs, which may benefit railroads, airlines, and shipping logistics providers (though lower fuel surcharges may mitigate benefits).

-Stellar cost management. Profit margins for S&P 500 companies remain near record highs and, we believe, probably held up well overall during the first quarter of 2015. Wage gains are the biggest component of the S&P 500 companies’ costs, and wage gains remain moderate at about 2% despite the drop in unemployment (based on the March 2015 jobs report). Commodity prices are another big corporate cost and those prices — even beyond oil — continue to fall. The Bloomberg Commodity Index has fallen about 4% year to date after a double-digit decline in 2014. And borrowing costs remain low.

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