Alcoa (NYSE:AA) is going to release Q2 results on Monday, July 11th, marking the beginning of the quarterly earnings season of US companies.
It will be followed on Thursday by JPMorgan (NYSE:JPM) and the following day by Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C), which will provide more information on the health of the financial sector. On Tuesday the 19th, the publication of the results of Yahoo! (YHOO) and Microsoft (NASDAQ:MSFT) will be the first for the technology sector.
Analysts' expectations for Q2 are for a continuation of last few quarters negative trend. According to Factset consensus estimates, analysts expect a 5.3% YOY earnings decline in Q2. It would be the fifth consecutive quarterly declining of profits. It would be the first time since 2008/2009 that profits drop for 5 consecutive quarters. Over the last few weeks there has been a downward revision of the estimates, which are now 2.6% lower than on March 31. However, according to Factset data, this downward revision is lower than the average of the last five and ten years, at -4.4% and -5.5% respectively.
The decline of earnings should be led by energy companies, estimated to post a 77% drop of earnings. Telecom and consumer discretionary should record the highest growth rates at + 7.3% and + 6.6% respectively.
Falling profits in Q2 would have the consequence to further lower the possibilities that consensus estimate for earnings growth of 13.8% (Standard & Poor's consensus) in the current year can be achieved.
GDP growing by 2% in real terms and not more than 4% in nominal terms and the negative impact of the strength of the US Dollar against major international currencies on Companies foreign activities could weigh on corporate profitability in the coming quarters.
In our view, the outlook of US companies' profitability in the coming years is also cast with clouds. The most negative indication comes from net profit margin, calculated as corporate profits after taxes, depreciation and inventory valuation divided by nominal GDP. As indicated by the following graph, a high net profit was followed in the past by modest earnings growth in the following 5 years and vice versa.
Despite declining from the peak of 12.6% in 2012, net profit margin was at 10.6% in Q1, a value higher than the long-term average of 9.4%, signaling modest growth over the coming years. According to our estimates, the current value of net profit margin suggests a 4.6% CAGR of earnings over the next 5 years.
The decline of the spread between the 10 years and 2 years government bond yields is a negative indication for earning growth over the next 3 years, as indicated by the following charts.
The possible downward revision of overly optimistic earnings estimates in H2 and the weak growth rate of earnings in the coming years could weigh on the performance of the S&P500 in the months to come. The S&P500 is now trading at a forward 12 month P/E ratio of 16.4x, above the 5-year average of 14.6x and the 10-year average of 14.3x.
In this scenario it seems unlikely that new gains of the S&P 500 will be driven by a further expansion of P/E. Only earning growth could permit a further positive performance of the major US equity index. Unfortunately, the earnings growth outlook suggests only modest gains.
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