Morgan Stanley Thinks Earnings Expectations Are A Little Too High

Thomson Reuters, Factset, Morgan Stanley Research

It's the last day of September, which means Q3 is wrapping up and earnings season will heat up in just a few weeks.

Analysts expect S&P 500 companies to report 5% year-over-year earnings growth.

Morgan Stanley's Adam Parker expects companies to report estimate-beating revenues, but earnings that fall short of expectations.

The ratio of negative to positive guidance versus consensus estimates is high at 3.29 for Q3, as companies continue to lower analyst expectations. Parker believes companies are attempting to manage expectations because investors have punished the stocks of those that have issued guidance below consensus expectations and rewarded those who exceeded analyst estimates.

However, he also believes that estimates have "further to fall".

"We continue to believe estimates are too high as analysts are embedding 7% earnings growth in 2013 to $110 per share, followed by 11% growth in 2014 to $122 per share," wrote Parker. "Our top-down estimates remain below consensus- $106 and $112 of earnings per share in 2013 and 2014, respectively."

Here's more of what Parker will be looking for this season:

... Capital Spending remains a hot topic, and we are looking for signs the companies in technology, industrials, and consumer feel the need to add capacity. We are not expecting big currency / commodity impacts during the quarter. Financials had a strong Q2, and volatility in interest rates will be a key variable during Q3 earnings and guidance. Lastly, we are curious about any commentary from companies with concentrated emerging markets exposure.

For his clients looking for an investing strategy, Parker recommends underweights in consumer discretionary and consumer staples, and overweights in health care, technology, and industrials.