What Do the Earnings Estimates Say About the Market?

04/10/2015 12:01 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

As earnings estimates for the quarter continue to move lower, MoneyShow's Jim Jubak shares his thoughts on how the stock market may react.

Estimates for first quarter earnings growth—I guess negative growth is still growth—for the earnings season that starts on Wednesday, April 8, continue to come down. Most recent surveys—basically, they do this by talking to all the analysts who follow the S&P 500 stocks and see where they are—anyway, for the quarter, the estimate for earnings growth for the S&P 500 stocks is now down to a -5.8% so they're expecting earnings for the group to fall by 5.8%.

Now, normally, there are two possibilities in this case. One is that the market has been falling going into earnings season so that you've got analysts that are so negative that only seeing a 4% decline instead of a 5.8% would lead to a rally.

We're not there.

The market has actually been either stable or actually moving up so we're not going into this disappointing earnings season with a pullback in the market. In fact, we're going in with the market really, really high, so the possibility here is that we're going to see these estimates, which are not secret, take the market down.

The big question is the story that I keep starting to hear to justify not selling at this point on earnings and the story, basically, is that most of the downgrade, in fact, all of the downgrade is due to energy stocks, that if you take energy's earnings out of the S&P 500, you wouldn't be seeing a -5.8%. You'd be seeing—oh, what is the figure—a positive almost 2% growth for the quarter, so hey, there's no reason to sell on this because it's all about energy.

We all know the energy story. Everybody sold energy, so no big deal.

The problem, of course, is that 1.9%, 2% earnings growth is not particularly strong. It's a very, very weak quarter so even if you're taking energy out, you're not showing much growth and the other thing is that energy is a kind of flexible category that, of course, an oil company like ExxonMobil (XOM) belongs to the energy sector and probably an energy drilling and services company like Schlumberger (SLB) belongs to the sector but what about a railcar company like Greenbrier (GBX). They make a lot of tank cars. Do they belong to the sector?

There are a lot of places where you can draw the line and say in the sector, out of the sector, and it gets kind of iffy in terms of drawing those margins, so saying you're going to take the energy stocks out is a fairly loose exercise, loose definitions and the other thing is that if that's your story going in, then that means that you do still have a chance for a negative surprise.

If, basically, you're saying, “Hey, earnings are going to be okay because they're going to grow by 2%,” if we throw out all the energy stocks, that means that you've got a possibility of a negative surprise if the strong dollar hurts earnings more outside the energy sector than anticipated, so I'm really worried about this earnings season. It's not just this quarter. It's this quarter and next quarter.

Next quarter, again, if you take all the S&P stocks, you're looking at projected right now—what is it—we're looking at a drop of about 4.2% projected by Wall Street analysts. If you take out the energy stocks, you're looking at about 3.4% growth for the second quarter. Those will tend to come down over time is my guess.

That's the usual pattern, so that you'll see the negative numbers rise, the positive numbers fall as we get closer to second quarter earnings so we're looking at two quarters of fairly weak earnings and that's what I'd worry about with the market at these levels.

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