MORGAN STANLEY: We Now Think ‘Good Is Good And Bad Is Bad’

adam parker

The second quarter just ended, which mean Q2 corporate earnings season will begin in just two weeks.

Adam Parker, Morgan Stanley’s top U.S. equity strategist, has long argued that earnings growth expectations need to come down. And he believes this will be the season when we get the bad news needed to get those forecasts down.

“[S]econd quarter earnings season is just around the corner and we think it will be more critical than normal,” wrote Parker in a new note to clients.  “Why? Because unlike earlier this year, we now think “good is good and bad is bad,” meaning the fundamentals will be in focus.”

For a while, many have argued that bad news was good because that meant that Fed would be increasingly likely to extend monetary stimulus, which has been attributed to strength in the stock markets.

“Downward earnings revisions have persisted in recent months with 7 of 10 GICS sectors seeing lower estimates over the last 3 months, and we continue to believe estimates have further to fall. Analysts are embedding 7% earnings growth in 2013 to $111 per share, followed by 11% growth in 2014 to $123 per share. Our top-down estimates are more muted— $103 and $110 of earnings per share in 2013 and 2014, respectively.”

Here’s what Parker will be looking for in the earnings announcements:

What we will be watching this earnings season:
Revenue and Earnings
: After beating on earnings but missing on revenues in Q1 (Exhibit 2), can companies beat consensus Q2 estimates on both revenue and earnings?
Do we see a slowdown in the rate of negative forward guidance?   
Capital Spending: Are companies in technology and industrials seeing capacity constraints, growing order backlogs, tight inventories?    
Fed Tapering / Interest Rates:
Are non-financials focused on the recent moves in the yield curve?    
Foreign Exchange:
Has the year-to-date move in the Japanese yen, in particular, had a material effect?
Domestic Demand:
Do we see an early indication of the expected second-half bounce-back in US economic growth and is that reflected in guidance?