My Expectations For This Earnings Season

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Includes: AA, DIA, IWM, QQQ, SPY
by: Healthy Appreciation

Summary

Oil prices, slowing jobs growth, and foreign currency concerns have all placed pressure on companies this past quarter.

However, share buyback programs, an accommodative Fed and recent market trends are all tailwinds for investors.

Keep an eye on the number of negative earnings surprises compared to positive surprises; this could be a sign the market is ready to head south.

However, until the current trend is broken, we will remain in the current upward trend and some amount of bullishness is warranted.

Alcoa Inc. (NYSE:AA) kicked off the first quarter earnings season on April 8th, with many investors asking what is in store for equities in the second quarter and beyond.

Alcoa Takeaways

Generally speaking, results from Alcoa were positive. Weakness was noted in Asia, Europe and South America in the heavy duty truck and trailer segment. Meanwhile, global demand for aluminum was stronger than expected. Also of note in Alcoa's earnings release was the absence of discussion concerning the impact of a strong US dollar on earnings, due to Alcoa's exclusive use of US-dollar sales. Overall, there did not seem to be any earth-shattering realizations to draw from Alcoa.

Results to Date

As can be seen below, there have been roughly 40 companies reporting 4/8 through 4/10. Of these, roughly 40% have made or beat earnings expectations while the remainder have not. The table below shows the number making and missing each day, as well as the median surprise % within each category. It should be noted that many of the numbers include companies still reporting on 4th quarter 2014 results. On the one hand, these companies are reporting on an earlier timeframe. However, it's still important to investors now because it's information hitting the market.

Earnings Info to Date
  4/8/15 4/9/15 4/10/15
#Making / Beating 11 5 0
Median Surprise % 8.3 53 -
# Missing 11 10 2
Median Surprise % -83 -38 -39

Source

By the numbers, more companies are recently reporting earnings misses than beats. In addition, the magnitude of the misses appears to be bigger than the magnitude of the beats. Based on the small number of companies reporting so far, investors might not put too much weight into these numbers. However, the trend appears to warrant some measure of concern throughout the next several weeks.

US Dollar Rally

The US dollar rally has been significant and rapid. In retrospect, it should not have come as such a surprise as the curtailing of quantitative easing in the US coupled with the initiation of the Japanese and European quantitative easing would serve to dilute the foreign currencies while simultaneously strengthen the US dollar. In addition, recent speculation that China may be next would serve only to strengthen this trend. As can be seen in the chart below, the Amex Dollar Index has risen in the last year by about the same amount the foreign currency index, FXE, has fallen: 22% In addition, the price of gold looks to have qualitatively mirrored the S&P 500 on performance basis, gold being down while the S&P is up.

^DXY Chart

^DXY data by YCharts

A stronger US dollar and comparatively more volatility overseas would serve to effectively lower rates. In other words, more demand is created in the US dollar. What it means for investors is to be wary of companies with large international exposure and foreign currency sales, because it translates to lower revenues on a US dollar basis. Based on the chart above, a rough order of magnitude estimate of the negative impact on first quarter US earnings attributed to foreign currencies would be about twice what it was in the fourth quarter of 2014. On the other hand, companies reporting blow-out earnings like Apple (NASDAQ:AAPL) did for the fourth quarter may not even mention the foreign currency impact if it is negligible by comparison.

Oil Prices / Fuel Costs

Expect the big oil companies to be negatively impacted by low oil prices. Even if a fundamental bottom in crude oil prices has already occurred, the average price per barrel in the first quarter was still roughly 20% lower than the average price in the fourth quarter of 2014. (See below). This oil price impact will be seen in a number of ways this earnings season. First, oil companies will have taken much of their highest cost production offline, focusing on their lowest costs installations. Secondly, lower fuel costs at the pump mean more money in consumers pockets. Airlines will see continued strength on lower fuel costs while transportation stocks will not be in such great shape due to lower fuel surcharge revenue and lower shipments of basic materials (i.e., like sand used in hydraulic fracturing which is expected to also see decreasing activity, etc). In fact, Dow theorists will argue there are bad things to come for the industrials based on recent weakness in the transports. However, an alternative explanation is that we are seeing a general shift to an information economy and the shipping of goods and raw materials has become less important.

WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts

March Jobs Report

Based on the April 3rd jobs report, 126,000 jobs were added in March which was roughly half of the 245,000 that were expected. The market tends to overreact when expectations are missed, even though it's largely a good thing that the economy is still adding jobs and unemployment remains at 5.5%. It is perhaps another indication that the economic recovery is losing steam. Still, the fact that the discussion seems to have shifted to wage growth can be taken as a good sign that employment is not as much of a concern as it once was. In addition, more people with jobs can only enhance consumer spending power, even if wage growth has been stagnant.

First Quarter Sector Performance

Looking at the first quarter S&P 500 sector performance breakdown, health care and consumer discretionary were the two strongest performing sectors. Meanwhile, financials, energy and utilities faired the worst. In addition, based on the Fidelity's viewpoint, the US market is still mid-way through the business cycle where growth is still seen as peaking prior to moderated growth later in the cycle (which we have yet to arrive at).

Two Life Jackets for Stocks

More than one recent report have indicated that company stock buy-back programs are at all time highs. This is helping to keep valuations robust. The pace of buyback announcements also does not seem to be slowing. For bullish investors, this is a good thing as it is likely that companies will buy into any near-term market corrections. In addition, it appears the Fed is now more likely to wait until September before raising rates, rather than June which was originally expected. Either way, the Fed has proven to be more than accommodative and is unlikely to make any sudden or drastic moves. Any rate hikes will be gradual, at least at first.

Recent Trend

The recent trends for the Dow (^DJI), S&P 500 (^GSPC) and NASDAQ (^IXIC) have all been positive. Over the past 8 quarters, they are up 24%, 35% and 54% respectively. Chartist would argued that until a trend is broken, we will remain in the current upward trend.

^DJI Chart

^DJI data by YCharts

Summing it All Up

During the current earnings season, energy prices will continue to weigh on companies, both positively and negatively while foreign currency impacts will be mainly negative and of a greater magnitude than in the previous quarter. Jobs growth has slowed but the number of jobs is still increasing. With a higher number of people receiving a paycheck and lower fuel prices at the pump, consumer discretionary stocks will continue to be strong, even in the absence of wage growth. Stock buybacks (at an all-time high) and an accommodative Fed are both positives for investors. Keep an eye on the ratio of positive to negative earnings surprises. If the negatives greatly outnumber the positives, this market could turn south quickly. However, until the that happens and the current trend is broken, I remain strongly in the bullish camp.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.