Earnings expectations for the first three months of 2015 have plummeted. Since January analysts reduced their estimates for company profits so much that earning will be considered on target even if they are 4% less than last year. Stock market bulls who are comfortable buying the market at current levels believe that the second half of 2015 will see an acceleration of activity which will more than justify expensive PE ratios. The Fed was forced to rethink the timing of interest rate increases because of a series of poor economic data point.
For our part, we are positioned with a healthy cash cushion because we are suspicious about where this excess demand will materialize from. China growth is very weak, Japan is no better and other than Germany, Europe is resorting to artificial stimulus through the ECB to stave off a recession. Despite this overwhelming body of evidence, the S&P 500 is still trading at 17 times forward earnings – a valuation that is normally reserved for periods of steady, predictable earnings growth. The stakes for US stock investors couldn’t be higher than right now.
Alcoa kicked off earning season last week with earnings per share that was 2 cents better than the reduced guidance but revenue that was less than expected. On the day the stock dropped 3% and is down more than 10% this year.
As more companies announce their financial results here are two key factors that investors should be paying attention to:
Over a three month quarter most competent CFOs can manufacture a decent report or at least offer a plausible excuse (weather, the dollar) for any shortcomings. Dig into their business to discern any change in demand trends. This is most readily measured through top line revenue and through inventory. If demand is strong, revenue will be up and they will be turning their inventory over faster.
Is the strong dollar helping or hurting business
Companies that have little international sales exposure should realize economic benefits from the strong dollar. They produce in dollars and sell in dollars. Domestic businesses are more focused on controlling manufacturing costs and inventory than their exposure to the strong dollar. The dollar rally was a primary driver in the decline of energy prices over the last 6 months and that should provide a cost savings to domestic producers.
US companies with a global footprint are still dealing with the effects of the strong dollar. The dollar rally has persisted long enough that these companies have had enough time to hedge some of the currency risk away. If they use the strong dollar as an excuse for missed expectations it likely means they aren’t managing their business well and will subject their shareholders to more earnings uncertainty.