April 7, 2016 / 11:07 AM / in 2 years

Weak U.S. earnings expectations set stage for stock gains

NEW YORK (Reuters) - When Wall Street’s quarterly earnings season kicks in to high gear next week, hundreds of companies will vie for the bragging rights that come from “beating the Street” - showing revenues and profits that are higher than analysts expected.

Traders work on the floor of the New York Stock Exchange (NYSE) April 5, 2016. REUTERS/Brendan McDermid

That hurdle may be unusually easy to clear this quarter, as analysts, who saw oil prices and stocks collapse at the start of the year, went really negative on the first quarter of 2016.

While the majority of companies typically beat forecasts, the bar for positive surprises may be even lower this time around, with analysts expecting profits of S&P 500 companies to be down 7.4 percent from a year ago, according to Thomson Reuters data.

With a handful of early reports coming in well above expectations and some evidence of stability in two company-hurting trends - falling oil prices and a rising dollar - some strategists are predicting enough positive news in an otherwise negative earnings season to boost stocks at least in the short term. In order words: First quarter earnings will be bad, but maybe not that bad.

“For right now there’s more of a chance of a positive surprise than a negative surprise in earnings, and to the extent that positive surprises are generated, that creates buying,” said Bucky Hellwig, senior vice president at BB&T Wealth Management in Birmingham, Alabama.

To be sure, the first-quarter reports are not expected to be pretty. A decline would mark the third quarterly profit fall in a row, Thomson Reuters data shows. The energy sector, expected to have its first quarterly loss in at least 10 years, will be the biggest drag.

But by the end of the quarter some of the biggest negatives on company performance seemed to have abated.

U.S. oil prices, which had fallen to a low of about $26 a barrel by mid-February, had stabilized near $40 in March, providing some hope to investors in energy companies. [O/R]

At the same time, the dollar, which had hit U.S. corporations hard as it rose sharply in both 2014 and 2015, eased in the first quarter, with the U.S. dollar index .DXY down 4.1 percent in that period.

The dollar’s strength still could hit U.S. exporters, but its overall impact is going to be a lot less this earnings period relative to the last few quarters, said Dan Suzuki, senior U.S. equity strategist at Bank of America Merrill Lynch in New York. He noted that roughly one-third of S&P 500 revenues come from outside the United States.

Multinationals stand to benefit the most, he said.

COLLAPSE IN EXPECTATIONS

Some upside has already been built in to share prices.

The S&P 500 Index .SPX is trading at about 16.6 times its components’ earnings over the next 12 months, well above the long-term average of 14.7, according to Thomson Reuters data.

But roughly 80 percent of S&P companies that have already declared first-quarter results are beating expectations. That is higher than usual, and includes strong performance from a diverse group of companies, including Lennar Corp (LEN.N), FedEx Corp (FDX.N) and Adobe Systems Inc (ADBE.O).

Furthermore, analysts who started the year expecting a 2.3 percent increase in S&P 500 earnings may have gone overboard with downward revisions as the gloomy quarter unfolded.

It was “an absolute collapse in expectations,” said Jonathan Golub, chief equity strategist at RBC Capital Markets in New York.

The drop in analysts’ views between Jan. 1 and now was almost triple the typical 3.5 percent preseason decline, he said, and “about as bad as we’ve ever seen, with the exception of the period going into the ‘08-09 crisis.”

For the first time since the second quarter of 2011, sales are expected to hold the line better than earnings. S&P 500 sales are expected to have fallen just 1.2 percent in the quarter.

In the end, investors may receive just enough good news to put a positive spin on an otherwise “pig of an earnings season,” Golub said.

Editing by Linda Stern and Matthew Lewis

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