Can Q2 earnings reinstate the customary “surprise”?

Revisions to quarterly S&P 500 earnings forecasts have followed a familiar pattern every quarter for a number of years, until the two most recent quarters.

Previously, in the year leading up to the beginning of the quarter, the forecast is reduced an average of 6%. Then during the quarter and right up to the report date, earnings are cut an additional 4%. Subsequently, when actual earnings are announced there is a positive “surprise” of around 3%.

This pattern comes from analysts and the companies they follow doing a quarterly ‘kabuki dance’. Nobody wants a negative earnings surprise since it would embarrass the analysts, company management and stockholders. Instead they would rather under promise and over deliver.

In the fourth quarter of 2015 the 5% cut during the quarter was a bit larger than normal and we were well set up for the usual “surprise”. This time, however, the surprise didn’t arrive.

During Q1 2016 earnings forecasts were cut a lot, by around 10%, which came mostly from energy and financial stocks and should have left plenty of room for a positive “surprise”. So far, with 74% of companies reported, actual earnings have been only 2.6% above the forecast, so the positive “surprise” pattern has returned, but only because the forecast was drastically reduced.

The first quarter is usually the worst seasonally for earnings and the US economy. Despite the grim result in Q1, spring typically brings higher hopes, and so far analysts are optimistic for better results for the rest of the year.

Jeffrey Ricker – Mellon Capital, a BNY Mellon company

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