It's the Earnings, Stupid
First Call thomsoninvest.net
IT'S THE EARNINGS STUPID! Forget the election (if only the media would let us!). It's emerging as a classic cyclical economic downturn, including a classic cyclical downturn in the technology sector. The warnings last week from Gateway and Ford Motor were particularly damaging.
Earnings estimates for 4Q00, 1Q01, and 2Q01 continue in free fall. Further downward revisions in 4Q00 and 2001 estimates are almost certain, particularly in those sectors sensitive to an economic slowdown, such as consumer cyclicals (which includes autos, housing, home furnishings, and retailing, among others), basic materials (paper, metals, and chemicals), capital goods, transports, and even technology, which are being impacted by the economic slowdown and/or the high energy costs.
This free fall in earnings estimates has led to great uncertainty as to how deep the downturn in earnings may be and when the bottom will occur. In our judgment, that uncertainty has been the main driver of the market. Surely, as it has in the past, the market will turn up before the bottom in earnings is reached. But it will have to have some reasonable visibility as to when and how deep the bottom will be.
That visibility is not yet present and probably will not be until at least late January. The rate of downward revisions may slow this month as the number of company earnings reports dwindles to a trickle, as company meetings with the investment community come to a halt as we near the holiday season, and because the build up of pre-announcements to peak levels by the last week of the quarter in other quarters gets pushed into January in the fourth quarter because of the holidays. Therefore, the real test will come with the flood of pre-announcements in the first few weeks of January.
That period will most certainly bring additional downward revisions and give us a good handle on where 1Q01 earnings growth will end up, but whether it brings into any better focus when and how deep the earnings bottom may be will be the big question. Based on the current estimate revision patterns, the earnings bottom is unlikely to occur before 2Q01 at best.
So far the estimates for 4Q00 S&P500 earnings growth have dropped from 15.6% to 10.0% since 1 Oct, the beginning of the quarter. That includes the Friday guidance from Ford, which sliced 0.02 percentage points off the expectations. Since 1 Oct, expectations for 1Q00 have dropped from 14.2% to 10.5%, but that does not include analyst reaction to the Ford guidance for 4Q00.
We had been referring to the technology sector as the wild card, since we weren't sure of the underlying causes of the estimate declines, and therefore, not sure whether the estimate cutting would continue. However, as each day goes by it is looking more and more like the traditional cyclical downturn in technology earnings. Since 1 October, earnings growth expectations for the tech sector has dropped from 29% to 14% for 4Q00 and from 28% to 14% for 1Q01. We now think that further substantive cuts on 4Q00 tech estimates will follow.
Tech earnings were up 42% in 3Q00, so a fall off to 14% or less in 4Q00 is a huge decline. It is even worse in the context of 4Q99 being somewhat soft because many computer hardware and software companies saw results slow in that quarter as many users had completed Y2K purchases, but were reluctant to take in new products until Y2K was past.
In the beginning of the quarter, it seemed the downward revisions in estimates might be due to a number of company specific problems, or possibly a short term inventory problem, but as it broadened to a wider array of companies, it seemed like something deeper. The announcement two weeks ago by Avnet, the leading electronic components distributor, was particularly troubling, as were the reasons given last week by Gateway for its warning. The distributors are often the canary in the coal mine in being among the first to see a cyclical slowdown.
The other major sector that has been had hit has been the consumer cyclicals. With the inclusion of the Ford 4Q00 guidance, the 4Q00 estimates for the sector have dropped from 10% gain to a 2% decline since 1 October. Given that 3Q00 earnings were down 7% for the sector in 3Q00, even a decline of 2% in 4Q00 is still too high.
Pre-announcements for 4Q00 continue to run significantly ahead of those for 4Q99. The percentages of negatives is similar, but the impact on earnings revision activity is radically different. Part of the increase is the deteriorating earnings environment, but part is clearly the result of Regulation FD.
Earnings Season
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