Brexit has the headlines, followed by the Italian banking Crisis and of course the new record set by the S&P 500.
The fundamentals remain on the back pages: I had to look long and hard in the Wall Street Journal for what is normally front page news: Alcoa earnings, which traditionally begin the "earnings season".
No big surprise when I found it: "revenue fell" (10%) and "profits dropped" close to 4% from a year earlier. Of course, these were "ahead of expectations".
What does that mean, "ahead of expectations"?
Basically, the analysts that cover Alcoa (and all the other S&P 500 companies) come up with anticipated earnings results (usually based on some guidance from the respective companies) in advance of the actual release. This allows "forward thinking" investors to determine whether they want to continue investing or not.
When a company "beats" those expectations (regardless of whether they are actually making earnings growth progress or not) there is usually cause for celebration and the share price goes up. Except if they guide to lower expectations farther out into the future.
According to Factset Earnings Insight: on average, over the last 4 years, actual earnings for S&P 500 companies have beat earnings estimates by 4% and 68% of companies have reported better than expected earnings growth. So basically companies like to set it up to garner the more positive news headlines of "beating" expectations.
That being the case, the current earnings growth estimate for Q2, 2016 which is anegative 5.4%, should probably come in somewhere around negative 2.7% based on the average of better than expected "beats" over the past 4 years.
But it is still negative!
And it could be the 5th quarter of consecutive negative earnings growth.
Doesn't that make you wonder why stocks are moving to record highs? The anticipated earnings growth for all of 2016 is just 0.5% (which includes a huge Q4 expectation of 7.2% earnings growth, unfazed by Brexit).
Central bank stimulus and / or lack of higher rates in the US is, for the time being, blinding investors to the realities of the fundamentals because they have nowhere else to go to get yield, despite the fact that forward looking earnings per share data are way above the average. The "risk-free" rate of return is pretty close to 0% ( wholesale 90 day Govt of Canada T-bills = less than 1/2 %), so every investment (that earns better than that) has significantly more relative risk attached to it.
Inflation, while low, is apparently still running in the 1.5-2% range (and as we all well know, our inflation experience may not necessarily be what the "basket" of goods is that makes up the Consumer Price Index data).
So anyone trying to stay ahead of inflation is likely taking more risk now than they ever have because we are in such a low return environment.
The current level of complacency is getting dangerous as investors move to higher yielding, riskier assets.
We shall discuss this and much more on our weekly client webinar today and post the recorded version on our website at or about 5pm EDT, so please feel free to tune in:
Thank you all for your feedback! Please keep it coming...all questions are good questions!
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Scott Tomenson,CIM Managing Partner, Chief Investment Strategist