A much weaker than expected Q1 gross domestic product (GDP) reading could be a red flag for corporate earnings. That means stock investors may need to adjust their expectations for earnings in coming quarters, especially if company execs are chirping their own concerns.
Most industry economists expected Q1 U.S. GDP—the broadest measure of the economy—at 1%, but the advance reading out last week (there will be revisions) revealed a mere 0.2% increase in growth in the first three months of the year. Ouch. That marks the worst economic performance since Q1 2014's 2.1% decline and is a big slowdown from 3.7% growth in Q4.
Some market watchers said poor weather was the culprit, and many noted that weak growth was also seen in early 2014 only to rebound later in the year. But will history repeat itself?
Not Apples to Apples
"When the first quarter GDP numbers came out, a lot of people said, 'Oh, don't worry about it. The same thing happened last year.' Is it really a simple case of déjà vu? There are a lot of differences now," says Sam Stovall, chief equity strategist at S&P Capital IQ.
One significant difference is that earnings are in a downtrend this year versus an uptrend last year.
"Last year S&P 500 [earnings per share] grew between 7.8% and 10.5% during the remaining quarters of the year, versus 2015 estimates of a 3.6% decline for Q2, a 0.2% decline for Q3, and a 3.7% gain for Q4," according to Stovall.
There are other factors at work as well, including a significantly higher U.S. dollar headwind for American multinational corporations and their exports. "The U.S. dollar index is up almost 20%, and a higher dollar makes our exports less attractive from a price perspective," notes Stovall.
There’s more. The price/earnings (P/E) on forward 12-month EPS was 15.9X at the end of April 2014, versus the current 17.7X, which means stocks are a lot more expensive now, says Stovall.
Quarterly Earnings: Good Time to Review Holdings
Quarterly earnings releases—we’re just past the halfway point for the latest batch of reports—offer investors a good opportunity to review their portfolio and assess current holdings.
"Investors should be putting their expectations for earnings growth in line with what the GDP figure is telling us," says JJ Kinahan, chief strategist at TD Ameritrade.
"Listen to what the CEOs and CFOs are saying on their earnings calls. Quarterly earnings are a good time to reassess if you still want to hold a company. Even with GDP churning near 2%, if your expectations for a company's earnings growth are 8%, that may not be realistic," warns Kinahan.
Preparation can be your friend. Investors can stay on top of corporate earnings news and estimates via the Trade Architect Research & Ideas tab (figure 1).
Consider Your Risk Profile
Wall Street has already lowered expectations for earnings growth later this year, which means that additional weak GDP readings could pack more punch.
Stovall warns against riskier stock moves based simply on the belief that the economy, earnings, and prices will bounce back this year as they did last year.
"You might want to maintain a neutral exposure to equities, fixed income, and cash that is appropriate for your age, time horizon, and risk tolerance. Now may not be the time to increase risk exposure," he said.