US profits melt away

Analysts covering US corporate results for the fourth quarter of 2014 have been too bullish. That’s no real surprise: in the past 39 years they have been too optimistic in all but six of them, says Avi Salzman in Barron’s. On average, every January, they foresee total US profits growth of 12% for the firms in the S&P 500 for the year ahead. By December, their expectations have typically plunged to 6%. But lately they have been racing to the bottom.

In the past month, we have seen the biggest drop in 12-month forward earnings estimates for the S&P 500 since the 2009 slump, as the FT’s James Mackintosh points out. As Wall Street analysts “are paid to be bullish”, they must be really worried.

There are two main reasons for the profits slide: oil and the dollar, down 40% and up 6% (on a trade-weighted basis) respectively in the fourth quarter. While a plunge in crude is a plus for the US economy, it hampers the S&P 500. Energy firms comprise around 12% of the index.

And while consumer goods and services jointly make up a quarter of the market, many of these companies earn much of their revenue abroad, so the stronger dollar affects them by weakening the value of their foreign earnings. About half of S&P 500 sales are made outside America.

As usual, it took analysts a long time to put twoand two together. Last October S&P 500 energy companies were expected to grow earnings by 6.4% in the fourth quarter, even though oil had been on the slide for some time. By December, the prognosis had switched to a 20% decline. This quarter, a 56% decline is expected. With around half of the companies in the index having reported, overall earnings growth is expected to be flat.

Executives are increasingly worried about the outlook: the number of firms downgrading their forecasts has eclipsed those upgrading by the greatest margin since the crisis. The dollar seems to have trimmed 3%-5% off estimates so far, estimates Goldman Sachs.

Bank of America Merrill Lynch thinks S&P earnings could expand by a mere 1% in 2015. In which case, the index is now on a forward price-to-earnings (p/e) ratio of 17.2, far above the ten-year average. In cyclically adjusted terms, the p/e is even more stretched. With stocks “overvalued and priced for perfection”, as the FT’s John Authers puts it, they look increasingly vulnerable to a nasty setback.

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