Just around the corner and fast-approaching are first-quarter corporate profit reports. Judging from the dismal results posted in the last two quarters (which I discussed here yesterday), you would think Wall Street analysts are drastically reducing their optimistic expectations … but you would be wrong.
In fact, Wall Street’s Pollyannaish analysts are expecting quite a rebound in first-quarter profits for the S&P 500. That’s a view that seems hopelessly out of touch with the current reality of a worsening economy. This increases the specter of another looming disappointment for investors. The market’s current fragile state may not be able to withstand more bad news without crumbling again.
To be sure, not all sectors of the S&P 500 are created equal. Some groups should make out much better than others. The devil, as always, being in the details. Let’s take a closer look at the numbers.
First the Bad News: S&P 500 Profits Unlikely to Live Up to Rosy Forecasts
S&P 500 profits tumbled 9% in the third-quarter, which ended in September. The parade of pain intensified on Wall Street in the fourth-quarter, with earnings plunging nearly 24% year over year. That’s the largest year over year profit decline in six-years! So what do analysts expect for this year: +17.4% profit growth for all of 2008!
You read that right, plus sign and all. Wall Street’s rosy forecasters call for a stunning upside reversal in earnings this year, starting with a gain (albeit just 1%) in first quarter profits. As you might expect, the second-half of the year is heavily back-end loaded. Current estimates call for 20% profit growth in the third-quarter and, get this… 59% growth in the final quarter of 2008. Let’s say I’m very… skeptical!
This is nothing new. Wall Street analysts are always behind the curve when it comes to a profit slowdown. They typically miss the timing of recessions (like the one we are probably in already), and it takes them forever to ratchet down these rosy estimates.
As the chart above shows, usually S&P 500 profits don’t bottom out until AFTER the recession is over before rebounding. Since the U.S. recession may have just started, I wouldn’t expect a big rebound in earnings anytime soon.
Now the Good News: Certain Sectors Have Strong Profit Prospects
As I mentioned yesterday (Will Floundering Financials Drag Down Overall Profits Again in '08?), the financial sector of the S&P 500 is the root-cause of the current profit decline. Outside financials, the rest of corporate America’s profit picture looks pretty good.
In fact, if you eliminate all the dismal results from banks, brokers, insurers (and other financial firms) overall profits for the S&P 500 would have been UP close to 12% in the fourth quarter – rather than DOWN 24%.
A few other sectors including consumer discretionary and basic materials also show declining earning growth, but there are also several bright spots. The technology sector for example is expected to enjoy 20% profit growth in the first-quarter of 2008. And here, analysts have been raising estimates based on a positive outlook from tech firms. Telecom shares too should enjoy healthy profit growth this quarter.
This all goes back to my central investment theme for 2008: selectivity is the key going forward. You must tip-toe through the mine field of earnings disappointments to find the few stocks and sectors that will shine.
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