As the dust settles from last week's Federal Reserve interest rate meeting, some investors may be wondering if the central bank knows something everyone else doesn't? After months of broadcasting signals that higher rates are just around corner, the Fed still couldn't pull the trigger on its first hike since 2006.
Could the Fed's concern about global economic developments signal more significant challenges for the U.S. economy? And just what clues about the economy's health might be lurking in Q3 earnings news due to hit over coming weeks?
What Does History Show?
Early estimates show the results might not be pretty. S&P Capital IQ estimates a 4.2% decline in Q3 operating earnings per share (EPS) for the S&P 500 (SPX). That would mark the first year-over-year decline in earnings since Q4 2009. For 2015 annual earnings, the SPX is expected to show a dip in earnings per share, which would mark the first full-year decline since the end of the last recession.
The numbers are sobering. "Since 1945, a majority of U.S. economic recessions were accompanied or preceded by downward trending growth in rolling 12-month EPS for the S&P 500, and only a handful of times did we experience a decline in EPS growth that did not result in a recession," says Sam Stovall, managing director at S&P Capital IQ.
However, for now, many economists believe the slowdown in the Chinese economy will not translate into a recession in the U.S. The U.S. imports four times as much from China as America exports to them, says Stovall. "They need us more than we need them. China is slowing simply because it is becoming a more mature economy. Its economic growth is still an enviable at 6.5%, it is just down from the 10% we saw prior to 2011," Stovall says.
There are also reasons for optimism. The hard-hit energy sector is a big factor dragging down the overall earnings outlook in Q3, which could be a transitory factor. Better earnings forecasts are dotting the horizon into next year.
Looking ahead, the 4.2% decline in Q3 earnings is expected to be followed by quarterly year-over-year advances of 0.2%, 5.5%, 7.2%, 14.5%, and 13.9% for Q4 2015 through Q4 2016, S&P Capital IQ projects.
This time around the decline in earnings estimates may be just a minor hiccup, not a major predictor.
"A worldwide economic slowdown, or even recession, continues to be of concern but is not the likeliest outcome, in our view,” says Stovall. “What’s more, the concern surrounding a profit recession—normally a reliable predictor of general economic contraction—is tempered by the prospects for a V-shaped quarterly earnings-per-share growth trajectory.”
Trading the News?
Nimble investors preparing for the upcoming barrage of Q3 earnings news can use the next few weeks to study up on their current holdings or stocks they may have an eye on.
"In this earnings environment, investors will want to understand the international exposure of their holdings. A higher domestic exposure might be more attractive to some investors right now," says JJ Kinahan, chief market strategist at TD Ameritrade.
TD Ameritrade clients can pinpoint historical earnings dates and view how a stock reacted in the past (figure 1).
It’s challenging to trade earnings news, as shares don’t always perform as expected. But therein opportunity can lurk.
"At the end of the day, you want to buy fundamentally solid stocks," Kinahan says. "You often see that the stocks that miss earnings targets can be hit hard and stocks that beat earnings expectations in these circumstances sometimes do really well. You then have to decide how that short-term performance fits in with your trading and investing goals.”
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