As you know, there is A LOT of optimism priced into the stock market right now. But with this “economic recovery” starting to sputter, and companies racing to adjust their earnings expectations DOWN, what will happen if a string of earnings disappointments comes in?
Being Street Smart
Earnings Will Follow the Economy – Down!
June 1, 2011
There is no credible argument anymore that the U.S. economic recovery is intact and only running into a brief slow patch. And a significantly weaker economy cannot support current earnings forecasts. Those are appalling conditions for an overbought stock market.
Wall Street has yet to begin downgrading its S&P 500 earnings forecasts, and probably won’t begin to any degree until its unavoidable, a couple of weeks before 2nd quarter earnings reports begin coming out.
But corporations are not waiting.
Already warnings that sales and earnings will be worse than currently expected have been issued by some of the world’s largest technology companies, including Cisco Systems (CSCO), Hewlett-Packard (HPQ), Logitech (LOGI), Nokia (NOK), Research in Motion (RIM), and Sony (SON); and major retailers including Home Depot (HD), WalMart (WMT), Sears (SHLD), The Gap (GAP), and Aeropostale (ARO).
And no wonder.
The merry month of May was anything but, with its reports of deteriorating conditions in April that were much worse than forecasts, as measured by the ISM Mfg Index, the ISM Non-Mfg Index, Factory Activity, and Industrial Production. There was the first drop to a negative reading by the Leading Economic Indicators in 9 months, the largest decline in Durable Goods Orders since last August, big plunges in new home starts and permits for future starts. There were big declines in existing home sales (now down 12.9% YTD), and home prices, while consumer spending rose in April by the smallest amount in 3 months.
Those reports were for April, the first month of the 2nd quarter. Now the reports for May are coming in, and are even worse.
In the last week or so it has been that the Empire State (NY area) Mfg Index, the Philadelphia Fed Index, and the Dallas (Texas area) Fed Index, plunged dramatically in May. Pending Home Sales unexpectedly fell 11.6% in April, to a 7 month low, a negative for actual sales in May and June.
This week it has been the Case-Shiller Home Price Index, which showed home prices fell again in March. In addition, the Chicago PMI Index dropped sharply, to 56.6 in May from 67.6 in April, Consumer Confidence unexpectedly fell from 66 in April to a six-month low of 60.8 in May.
And now we have the ISM Mfg Index shocking economists again by declining to its lowest level in 20 months, falling to just 53.5 in May from 60.4 in April, and the ADP jobs report showing that only 38,000 new private sector jobs were created in May, down from 177,000 in April, and in sharp contrast to the consensus forecast that 180,000 new private sector jobs were created.
A significantly weaker economy cannot support Wall Street’s current earnings forecasts, and since those super optimistic earnings forecasts have been the main support for the stock market, look out below as the market begins anticipating the downgrade of earnings estimates.
The market’s unfavorable season has just begun.