Looking at Earnings Estimates to Assess Market Outlook

Includes: DIA, QQQ, SPY, XLE, XLK, XLV
by: Erik Dellith

A little over a month ago, the stock market hit its recent peak, with the Dow Jones Industrial Average rising just above 12,800 and the S&P 500 Index over 1,360. It’s been a pretty tough go since then. The stock market has trended lower, as economic indicators have pointed to easing growth. In such an environment, one might expect analysts to reduce their estimates across the board. This is not necessarily the case, though.

Analyst Revisions

Much academic research has been done on analyst estimates. Not surprisingly, the farther into the future analysts estimate, the more those forecasts are wrong. No one has a perfect crystal ball. I look at earnings estimates more as a general guide, than a precise forecast. It matters less to me that an analyst expects EPS to climb 12.34%, than the expectation is for low double-digit earnings growth. If earnings estimates are heading higher, then the outlook is clearly improving. If estimates are falling, then conditions will likely deteriorate. After all, “it is better to be roughly right than precisely wrong.”

It is with this perspective that I take a look at the companies in the S&P 500 Index. I run a quick screen to see how analyst estimates have changed over the last month. Running the screen on Friday afternoon, I find that earnings estimates are higher now than they were a month ago for more than half of the companies in the S&P 500 Index. Indeed, the current year average EPS estimate is higher for 261 companies.

How about on the downside? I re-write the screen to identify the companies where the average current year EPS estimate is lower than it was four weeks ago. This screen returns 180 companies. Clearly, there are some companies where analysts have not changed their estimates.

With estimates heading higher at more companies than not, one could reasonably be optimistic on the entire index, especially when the recent losses are taken into consideration. A good way to make a play on the overall S&P 500 Index is through the SPDR S&P 500 Index Trust ETF (NYSEARCA:SPY).

What if the recent down trend in the S&P 500 Index has you concerned that momentum will continue to take this index lower? Perhaps you’re more interested in concentrating your exposure to specific sectors. Let’s take a moment to focus on where the changes have been taking place.

Sector Revisions

There are a dozen sectors: basic materials, capital goods, conglomerates, consumer cyclicals, consumer non-cyclicals, energy, financial, healthcare, services, technology, transportation, and utilities.

I’m not so much concerned at this point about the companies where earnings estimates haven’t changed. In thinking about sector exposure, I’m more interested in getting a general feel for the general positive-to-negative relationship. So, I screen first for the number of companies in each sector where earnings estimates are higher than they were four weeks ago. Then, I screen for the number of companies where the estimates are lower.

Here is the breakdown as of Friday evening:

Sector Higher Lower Ratio
Basic Materials 13 14 0.9
Capital Goods 17 5 3.4
Conglomerates 1 1 1.0
Cons Cyclicals 6 7 0.9
Cons Non-Cyc 19 13 1.5
Energy 26 12 2.2
Financial 36 36 1.0
Healthcare 26 13 2.0
Services 57 38 1.5
Tech 39 25 1.6
Transport 6 1 6.0
Utilities 15 15 1.0

Thus, we see that analysts are, generally speaking, more upbeat on companies in the capital goods, consumer non-cyclicals, energy, healthcare, services, technology and transportation sectors. Investors looking for exposure to stocks might want to start in these areas.

Investors seeking broad exposure to some of these sectors, however, may want to take a look at the sector S&P ETFs, including:

  • Energy Select Sector SPDR ETF (NYSEARCA:XLE)
  • Health Care Select Sector SPDR ETF (NYSEARCA:XLV)
  • Technology Select Sector SPDR ETF (NYSEARCA:XLK)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.