David Rosenberg: Here's What To Expect From The Coming Earnings Season

David Rosenberg

David Rosenberg of Gluskin-Sheff presents a good overview of what to expect from earnings season:


•    The consensus is looking for +24% YoY earnings growth.

•    Revenues are seen lagging behind once again, at +7%.

•    Strip out financials and operating EPS growth is seen at a more modest +18% (half the pace of the first half of the year).

•    Profit growth is slowing down, but not collapsing. That said, consensus estimates are probably still too high.

Two wild cards could be reduced guidance from the Tech and Transports sectors — we say that because of the comments on these two sectors coming out of the recent ISM survey:

Computer & Electronic Products
: “Strategic customers reducing order quantities.”

Transportation equipment
: “Customers seem to be pulling back on orders. I suspect that they are trying to reduce their inventory for the approaching year- end.”

Going forward, here is the challenge. The consensus is still looking for $95- plus on U.S. operating EPS growth for 2011, but at a time when profit margins are at a cycle high, not a trough. There is a difference. At troughs in margins, profits, on average, expand at six times the pace of nominal GDP growth in the ensuing year. But when margins are at a cycle high, we find that on average, profits invariably end up lagging well behind nominal GDP growth and, in fact, decline in the next year by 3% on an average basis, and close to 5% on a median basis. As a result, it may be more prudent at this juncture to be valuing the equity market on $75 of S&P 500 operating earnings next year than on $95. Slap on an appropriate multiple and you can see why an underweight position still makes sense, speculative QE2 fervor notwithstanding.

All we know is that in the aftermath of the very soft ISM and nonfarm payroll reports for September, double-dip risks, as they pertain to the U.S. economy, have not exactly disappeared. So it would stand to reason that an equity investor would rather own sectors that have low as opposed to high correlations with the U.S. economy. The sectors with the highest correlations are industrial, financials and technology. The sectors with the lowest correlations are health care, energy and utilities.

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