MARKET EARNINGS
2Q01 Earnings Reporting Season Now Effectively Over
The past two weeks were the peak reporting time for companies with a July ending quarter. Except for a few stragglers, the 2Q01 reporting season is over. About 99% of the S&P500 companies have reported, as have 95% of the S&P600. At this point, the aggregate data for 2Q01 earnings are virtually cast in stone. Only 7 S&P500 companies and S&P600 companies remain to report.
It is highly likely the final 2Q01 results for S&P500 earnings will show a year-over-year decline of 17.0%. More companies than usual have matched expectations, while somewhat less than usual have beaten and somewhat less than normal have missed. That is the result of the almost record level of pre-announcements for 2Q01.
Small cap earnings in 2Q01, as in recent quarters, did better than large cap. Earnings for the S&P600 will likely be down 12.0%.
Earnings Estimate Revisions in Midst of Three Week Seasonal Slowdown
Last week earnings warnings and revision activity slowed because of a slowing in the pace of 2Q01 earnings reports and their accompanying guidance on the outlook, and because many analysts were on vacation. That will be even more so the case this week and probably next week. However, as we get further into September, the pace of pre-announcements will accelerate rapidly, and revision activity will likely surpass the peak activity earlier in 3Q01.
Even though warnings are in a seasonal slowdown, the number of 3Q01 earnings warnings continues to climb and remains at a record setting place. There were 31 last week, bringing the total to 358. That is 8% ahead of the 332 at the equivalent point in the record setting 1Q01. The 358 is more than 5 times the 68 at the equivalent point in the fairly normal year ago 3Q00.
Nevertheless, there was some further downward revisions in both S&P500 and S&P600 earnings last week. The downward revisions were modest, but not trivial, particularly considering it was part of the slow period for the quarter. The recent trend of a widening gap between the expected earnings declines for large caps and those for small caps continued.
For 3Q01, the estimated declines fell 0.6 percentage points to 14.0% for the S&P500 and fell 1.0 percentage points to 18.8% for the S&P600. For 4Q01, the estimated declines fell 0.6 percentage points to 1.7% for the S&P500 and fell 1.4 percentage points to 4.9% for the S&P600.
Slashing of Earnings Estimates Likely to Resume in Mid-September
With earnings warnings continuing to run at a record setting pace, it seems inevitable that warnings will accelerate as September unfolds. The peak weeks for warnings usually are the last week or two of September and the first week or two of October. Therefore, further cuts in 3Q01 and 4Q01 earnings are likely. By the start of the 3Q01 reporting season in the second week of October, the 3Q01 earnings decline is likely to have been cut from the current 14.0% to about 19%. Actual results are likely to beat the final estimates by about 2%, bringing the final number for 3Q01 to about a 17% decline.
Similarly, the earnings estimate for 4Q01 is likely to drop over the same period from a 1.7% decline to a decline of about 7%. If warnings and revisions revert back to more normal patterns in 4Q01, that would imply the final results would be a decline of about 5%. However, that is likely the best case scenario. If the current warnings and revision patterns persist until January, that would imply a decline of about 10%.
Because the comparisons to year ago results get easier in 4Q01, a decline of 5% to 10% in 4Q01 would imply that 4Q01 earnings seasonally adjusted would be down from 3Q01 earnings.
Consumer Cyclical Sector Earnings Estimates Take a Tumble
Most of the retailers reported earnings last week or the week before, so the earnings information focus, particularly within the consumer cyclical sector, had been on the retailers. Unfortunately, the market got blindsided by Ford. The Ford announcement of production cutbacks and the pre-announcement on 2H01 earnings led not only to earnings estimate cuts on Ford, but also on its competitors and its suppliers. The impact of the bad news in the auto and retail industries resulted in a sharp cut over the last two weeks in consumer sector earnings estimates.
During those two weeks, the estimate for 3Q01 earnings dropped from a 2% decline to a 7% decline, while the 4Q01 estimate dropped from a 16% increase to a 9% increase. Even with the cuts, the year-over-year numbers imply that 3Q01 consumer cyclical earnings will be up from 2Q01. However, the 3Q01 year-over-year number benefits from a much easier comparison to the year ago quarter than did 2Q01.
More foreboding is that the 1Q02 estimate was cut from a 30% increase to a 26% increase. Prior to two weeks ago, 3Q01 and 4Q01 consumer cyclical sector estimates had been cut somewhat more than normal, but not as much as many other sectors or as much as the consumer cyclical sector estimates had been cut for prior quarters. Until two weeks ago there had been virtually no trimming of 1Q02 estimates.
So far, 76% of the 136 retailers in the First Call retail index have reported 2Q01 earnings. The number showing an earnings decline from 2Q00 slightly exceeded the number showing an increase. Only 49 were up from last year, while 61 were down, and 6 showed no change in year ago eps. Using the actual 2Q01 results for those who have reported and estimates for the remainders, 2Q01 retail earnings are heading for a decline of 6.0%.
Relative to expectations, 55% beat, 35% matched, and only 9% fell short. At first blush, that looks encouraging, but the problem is that most of the retailers had warned ahead of the actual results. Out of the 136 retailers, 35 warned on 2Q01, with 7 of those warning a second time. Already, 27 retailers have warned on 3Q01 earnings.
The August auto sales, due out on Tuesday of next week, and the August same store sales, most coming out on Thursday of next week, should be very informative. Hopefully, they will not lead to a downward revision rate in estimates that matches that of the last two weeks.
Have Patience; All May Not Be Lost
Most investors appear to be counting on 1Q02 for the start of the earnings recovery. Meanwhile the earnings foghorn keeps blaring its dismal warning signals. At the moment there is no confirmation that that is likely to happen, but there is no confirmation that it will not. It will probably be late September or early October before the fog lifts on the 1Q02 earnings outlook.
The pattern on earnings warnings and downward revisions has been a recurring nightmare for almost a year. At the beginning of each of the last three quarters (4Q00,1Q01,2Q01) and at the start of this one, the pattern has been the same. Warnings run at record levels (4Q00, 1Q01) or close to record levels (2Q01). Earnings estimates are slashed for the current quarter and the next quarter.
At the start of each of those quarters, here was hope of an earnings recovery two quarters out. But it was not until late in each quarter or shortly thereafter that the two quarter out outlook crystallized. Unfortunately, in all three cases, it became apparent that the earnings recovery would have to be pushed back a quarter.
As we head into the late stages of 3Q01, there is so far no signs of a change in the pattern. As we said above, there is no slowing in the pace of earnings warnings for the current quarter, and there is no slowing in the pace of downward revisions in earnings estimates for 3Q01 and 4Q01. If a recovery in earnings is going to occur in 1Q02, the rate of downward revisions in estimates, and eventually in earnings warnings, for 4Q01 need to show some sign of slowing. So far there is no indication of this. A second worrisome factor is that analysts have been cutting tech sector and basic materials sector earnings expectations for 1Q02. Those were the first sectors cut for 3Q01 and 4Q01.
On the other hand, 1Q02 earnings are likely to be the first to feel a meaningful impact from the Fed rate cuts of early this year. There was too much wishful thinking that the cuts were going to provide any help in 2Q01 or 3Q01, or much meaningful help in 4Q01. That means that, at the end of this quarter when the outlook for two quarters out comes into focus, this time there is a better chance the recovery will get underway two quarters out rather than get pushed back.
But it also possible that the early Fed actions were not enough, and that the recovery will have to wait until some of the later cuts have an impact on earnings.
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