Q2 Earnings Will Unveil Light at the End of the Tunnel - RBC

Despite some pretty gloomy predictions, second quarter earnings season will unveil some much-needed light at the end of the tunnel, says Miles Zyblock, chief institutional strategist at RBC Capital Markets.

"We believe there's a good chance that this quarter will represent a turning point in the proportion of companies reporting a positive earnings surprise," said Miles Zyblock in a note to clients.

The stabilization in our S&P 500 estimate revisions index – and the outright improvement seen in the revisions for four sectors – suggests that the underlying dynamics could be changing for the better.

U.S. earnings season tips off later today when Alcoa Inc. (AA) reports Q2 results after market close. Sell-side analysts expect S&P 500 earnings to decline year-over-year by more than 35% in the second quarter, with all 10 economic sectors contributing to the decline. If forecasts hold true, it will mark the seventh straight quarterly drop in profits, the longest losing streak in 70 years.

"It stands to reason that the anxiety level among the investment community remains elevated," Mr. Zyblock said. Still, he believes aggregate earnings data appears to be changing for the better.

For one, earnings estimates have remained stable 14 weeks after the beginning of the quarter. That compares favourably to the previous two quarters, when analysts "clipped" forecasts by almost 30%.

He also noted that negative pre-announcements heading into the second quarter were modest compared with previous quarters.

Of the 93 S&P 500 companies that have pre-announced so far, the negative to positive ratio stood at 1.5 times. This is significantly lower than last quarter's experience of 4.7 times and below the longer-term average level of 2.1 [times].

As earnings season unfolds over the next couple of weeks, energy and materials stocks are expected to show the largest percentage drop while the smallest anticipated slide is seen for the relatively defensive sectors, such as health care, consumer staples, utilities and telecoms.

From an outlook standpoint, Mr. Zyblock says four of the ten economic sectors are showing clear signs of improvement.

The strategist wrote:

Our earnings estimate revisions index has moved into positive territory for two pro-economy sectors – technology and consumer discretionary – as wall as for telecom and consumer staples, which are usually viewed as offering ballast during difficult economic times.