Earnings Season Is About To Begin - Here's What To Watch Out For

Second quarter earnings seasons is almost upon us.

To get ready for the torrent of corporate earnings report, Morgan Stanley's Adam Parker is out with a note outlining a few of the things he and his team will be looking for as companies update investors on their progress, and give clues as to how the economy is really doing.

At the top of the list: demand.

Via Parker:

"Signposts: During this earnings season, we want to hear management commentary on the level of both consumer and industrial demand. Using GDP to measure economic conditions is confusing. Did companies experience a Q2 rebound in activity after the US economy slowed more sharply than expected in Q1? In the same vein, we want to see if revenues can again exceed consensus expectations after beating them in the past four quarters. We are also on the watch for any company statements regarding the recent rise in the price of Brent, and what it might mean for costs in coming quarters. We will continue to monitor capital spending announcements (including backlog age and size and book-to-bill ratios in the technology and industrial sectors), inventory levels, and hiring as we remain focused on what costs are put in place by companies and whether this could introduce any volatility in 2H 2014 EPS estimates. Capital spending remains a critical investment debate, and we are looking for signs that companies within technology, industrials, and consumer see the need to add capacity. Overall, we maintain that capex-to-sales levels, particularly if we exclude energy and utilities, will at most rise only modestly."

As for the earnings themselves, Parker notes that Q2 estimates have been lowered relative to analysts' expectations, and the bar appears low enough to clear.

"Q2 2014 earnings expectations have seen downward revisions, and with the decline in estimates, we expect reported results to show modest upside as companies once again clear the lowered bar. Earnings for the group of companies reporting prior to Alcoa have been slightly above estimates. The sample size is small, but beats from FDX, ADBE, and MU have more than offset misses from ORCL, GIS, and DRI. For these companies, the market is rewarding companies that beat consensus earnings and revenue estimates and is punishing misses."

Parker notes that for Q2, the ratio of negative to positive guidance is 2.9, meaning there have been three instances of negative guidance for each instance of positive guidance. And due to this lowered bar for Q2 earnings, Parker expects companies, on net, to beat expectations.

This chart from Morgan Stanley shows the ratio of negative to positive guidance, which in Q2 was slightly above the historical average.

And while estimates for the second quarter have been reduced, Parker expects a further trimming in earnings expectations for 2014 and 2015.

Parker estimates that the S&P 500 will earn $116 per share in 2014 and $123 in 2015, while analysts currently expect earnings of $120 and $133 for 2014 and 2015, respectively.

But for 30 of the 38 year forward earnings estimates have been available, Parker notes that consensus expectations have been too high.

Here's where expectations currently stand.