Bank of America Throws In The Towel: “The Profits Recovery Won’t Live Up To Expectations”

Next week the second quarter earnings season begins in earnest (as usual with Alcoa reporting after the close on Monday), with some 5% of the S&P reporting Q2 results, a number which will rise to 89% by August 5.

During this period, most corporate buybacks, arguably the only source of stock buying, will remain in a blackout period. Whether this means the S&P will again remain rangebound for the next 4 weeks is unclear: with rampant central bank intervention now a daily fixture of “markets”, it remains a folly to attempt any predictions.

A more interesting question will be what earnings will be reported. As is widely known, Q2 will be the fifth consecutive quarter of declining earnings, the first time this has happened since the financial crisis. Curiously, in just the past week, analysts have further taken down their estimates, with average EPS now seen a declining 5.6% from a year ago, compared to a drop of 5.4% as of June 30 (with revenue set to drop by 0.7% Y/Y).

And for those wondering, no – it is not just energy companies whose earnings are plunging: as the chart below shows, a majority, or 6 of the S&P’s 10 sectors, are expected to report negative earnings growth with only Telecom, Consumer Discretionary, Utilities and Healthcare posting an increase (largely due to the daily ongoing collapse in interest rates to all time lows).

But while a Q2 earnings contraction is a given (even when factoring the last minute “beats”, which traditionally push up the final result by 3-4%), another question is what to expect out of Q3: will the earnings recession last for an unprecedented 6 quarters even as the S&P hits all time highs? For now, the answer is borderline: while consensus expects a sharp drop in the second quarter, Q3 EPS, as of this moment, are expected to rise a modest 0.7% (however this number too is declining).

 

To be sure, what is going on here is the traditional optimism bias prevalent among all analysts: we expect that as we get closer to the end of the third quarter, the Q3 EPS consensus will drop sharply lower.

And nowhere is this more evident than in a note released overnight by Bank of America’s Dan Suzuki who is the first analyst to admit that an earnings recession that will have lasted well over one year is not normal, and as a result he has thrown in the towel, saying that “The profits recovery is unlikely to live up to expectations.” Here is his full note which admits that the “hockeystick” EPS rebound in 2016 and 2017 is a mirage that will promptly float away in the coming months.

Cutting forecasts to reflect a weaker recovery

 

Trimming EPS by 3% in 2016 and 2% in 2017

 

In the wake of the weaker-than-our-expected 1Q results and recent macro headwinds, we are trimming our S&P 500 EPS forecasts by 3% in 2016 and 2% in 2017. Our revised forecasts of $117 (flat y/y) in 2016 and $125 (+7% y/y) in 2017 suggest downside to the bottom-up consensus of 1% and 7%, respectively. Excluding the extremely volatile earnings of the Energy sector, which we expect to decline by more than 50% for a second consecutive year, we forecast S&P 500 earnings growth to trend from 7% in 2015 to 0% in 2016 and 4% in 2017. At 2098, the S&P 500 currently trades at 17.9x our 2016E EPS while our year-end target of 2000 implies a 16x multiple on our 2017E EPS.

 

 

 

Headwinds from Brexit, pensions, FX and oil

 

As a result of the UK referendum, we now assume slower global growth and a modestly stronger dollar. Our biggest cuts for 2016 were to the global cyclicals’ earnings (Chart 2): Financials (-$14bn), Tech (-$11bn), Energy (-$10bn) and Industrials (-$5bn). We assume that the impact of net buybacks (+1ppt), a stronger dollar (-1ppt) and declining Energy profits (-2ppt) will result in a net drag of 2ppt in 2016 vs. a drag of 10ppt in 2015 (Chart 4 and Table 3). Excluding these factors, our forecasts imply a slowdown in non-Energy constant currency earnings growth from roughly +10% to +4%. See the detailed forecast table on page 3. Given the fall in interest rates this year, we think pension expense is likely to be another modest headwind to earnings growth next year. And just as the GAAP gap was closing, we could see it widen at the end of the year, as those companies that have transitioned to mark-to-market pension accounting take charges that hit GAAP EPS.

 

The profits recovery is unlikely to live up to expectations

 

Earnings season for 2Q is about to kick off, and despite our expectation of a 3% beat vs. consensus, we think S&P 500 EPS is still likely to come in below 2Q15. While this would mark the fourth consecutive quarter of negative y/y EPS growth, in our view, what is encouraging is that 1Q likely marked the trough. Despite the negative impact of the Brexit vote, we see EPS growth accelerating throughout the rest of the year, but not nearly at the trajectory of consensus expectations, which imply growth will accelerate from -6% in 1Q to +9% by 4Q (Chart 1) and +16% by 1Q17. And given the S&P 500’s 15% rally since mid- February, we are concerned that much of the improvement in earnings growth may already be priced in, especially with signs that earnings revision trends may be rolling over.

We expect other banks to promptly join the crowd and slash their own overly optimistic forecasts which will never materialize.

So does that mean that stocks will stop rising in a world in which they are unable to generate incremental income growth? Of course not: since the S&P’s GAAP PE is currently north of 24x, there is no reason central banks can’t push it even higher: after all any time the market has rallied over the past 1.5 years, a time when earnings have been steadily declining has been on multiple expansion. And since even the Fed admits the stock market is in bubble territory, saying “forward price-to-earnings ratios for equities have increased to a level well above their median of the past three decades“, and yet does nothing about it, we expect the bubble to keep growing ever bigger until the day it finally bursts. What concerns us more, however, is that the world will be engaged in both regional and global conflict and/or war at that time, for anyone to really care too much.

via http://ift.tt/29CDBph Tyler Durden

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