This earnings season may not bring the kind of surprises Wall Street is used to
As usual, analysts lowered their estimates for fourth-quarter earnings in the weeks leading up to announcements, which pick up pace this week.
But this time, the drop was below average, setting Wall Street up for fewer surprises, according to Julian Emanuel, US equity and derivatives strategist at UBS.
"While we expect earnings to surprise to the upside as is customarily the case, the fact that the decline in consensus estimates since the start of the fourth quarter was the smallest in 10 quarters likely limits the potential for upside surprise," Emanuel wrote in a note on Monday.
"Furthermore, the political uncertainty from a new incoming administration in DC makes it less likely that positive price reactions to "better-than-expected" reports will provide an upside catalyst for the broader equity market."
A pattern unfolds ahead of every earnings season: equity analysts reduce their estimates for earnings per share during the quarter. This lowers the bar that companies must clear to "beat" on earnings, and so many firms end up surprising with better-than-expected results.
The surprises prompt some shareholders and investors to buy more, lifting stock prices. And analysts, who realize that the quarter was not so bad after all, hike their earnings expectations as results roll in.
The before and after in expectations end up looking like this:
According to FactSet, the bottom-up EPS estimate (an aggregate of all companies) of the S&P 500 fell by 2.2% during the fourth quarter. This was lower than the average drop over the past year or four quarters (4.7%), the past five years or 20 quarters (4.3%) and the last 10 years (5.6%), said John Butters, a senior earnings analyst at FactSet, in a note Friday.
The potential for fewer surprises is not to say this earnings season will be shabby. One reason why analysts are not as pessimistic is that the third quarter ended five quarters of year-on-year earnings declines. According to UBS, the consensus estimate is for EPS growth of 4.6% year-over-year, which would be the strongest pace in two years.
Analysts are hopeful partly because the energy sector is expected to have less of a drag on the S&P 500, and expectations for financials have rocketed since the election. The big banks including Bank of America and JP Morgan will kick off earnings season in earnest before the opening bell on Friday.