Q1 2019 - Earnings Estimates Start To Fall Off A Cliff

The stock market is rallying way too much compared to how much earnings estimates are falling.

As you can see from the table below, Q1 EPS growth estimates have fallen from 5.54% at the start of the year to just 3.55% as of January 23rd. There are still a couple months before Q1 2019 earnings season starts.

That means there is still room for estimates to fall further if the firms which haven’t reported Q4 results yet have weak guidance. Q2 and Q3 estimates have fallen similarly as they are down from 5% and 4.91% to 3.62% and 3.37%. It’s possible economic growth rebounds by the 2nd half of 2019. But as of now, it looks like 2019 will have low single-digit earnings growth.

The Q4 EPS beat rate has been solid at 69.5%, but the sales beat rate is only 49%. During the trough of the financial crisis, firms beat sales estimates by about 45%. Firms can always beat EPS estimates if the bar is lowered enough.

The trend in earnings estimate changes has been negative. Earnings estimates started 2018 by being raised, but each subsequent quarter has seen them weaken more. By the end of 2018, estimates were falling.

Q1 2019 - Good & Bad Earnings News

The bad news is that estimates are now falling more than average. FactSet calculated the change in estimates for the 1st half of the following year in the period from October 15th to January 15th.

Estimates for 1H 2019 fell 4.5% which is worse than the 15-year average decline of 2.4%. Since the recovery started, only estimates for 1H 2015 were worse as they fell 6.6%. The sectors with the biggest estimate declines are energy, technology, and materials.

Their estimates are down 29.7%, 7.2%, and 5.7%. Energy earnings estimates can easily rebound if oil prices continue to rally as they have in the past few weeks. However, the weakness in technology estimates is more concerning as it signals global growth is slowing.

To be clear, energy is affected by global growth as well, but the price of oil probably got too low in December which means energy earnings estimates might improve modestly.

The good news is that stocks don’t necessarily need to crater if earnings growth is in the low single digits. Stocks fell more from peak to trough at the end of 2018 than they did from 2015-2016 even though there was an earnings recession in the latter period.

Estimates certainly aren’t headed in the correct direction, but the situation needs to continue to get worse to justify a bear market. It’s fair to say the rally in the first 13 days of 2019 was overkill, but the market shouldn’t fall to the Christmas Eve bottom until more bad news comes out.

Q1 2019 - Weak Richmond Fed Report

Now we have 3 of the January regional Fed manufacturing reports. Two out of three have been weak. The Richmond Fed report came in at -2 as you can see from the chart below.

This is an improvement from -8 in December and beat estimates for -3. However, since it is negative while the others have been positive, I count it as a weak one. The 3-month moving average has fallen to 1.3. Shipments index improved sharply from -25 to -8. The volume of new orders index fell slightly from -9 to -11. Capacity to utilization index was up from -16 to 3.

Local business conditions improved from -25 to -11. This report is different from most manufacturing soft data reports. It improved in the rate of change terms but was negative. Other reports mostly show weakness in the rate of change terms, but positive growth.

Q1 2019 - This report has been very volatile.

Sub-indexes vacillated sharply in the past month. That’s why the 3-month moving average might be the best indicator to follow. Capex index fell from 17 to 9 and the equipment & software spending index fell from 13 to 8. Just like the prior two regional Fed reports, the inflation readings weakened. Prices received index was flat at 2.26, but the prices paid index fell from 4.36 to 3.32.

This report doesn’t have an expectations index, but the future sub-indexes looked good. Only 4 out of 11 future sub-indexes fell. 6 out of 11 sub-indexes fell in the current index, and that one rose 6 points.

Specifically, the expectations for shipments and new orders were up from 19 and 15 to 29 and 31. Local business conditions and capex were up from 14 and 22 to 27 for both. Finally, expectations for prices paid and prices received fell from 2.9 and 2.31 to 2.48 and 2.

Q1 2019 - MBA Report Softens Slightly

It’s quite interesting how so many people are recognizing how weak the housing market got at the end of last year, while the indicators seem to be turning this year.

MBA purchase applications index was the highest of the cycle in the week of January 11th as the chart below shows. The 2nd highest reading was the week of January 18th.

This index fell slightly after spiking in the prior 2 weeks. Composite index fell 2.7%, the purchase index fell 2%, and the refinance index fell 5%.

Unadjusted purchase applications were up 13% which is nearly the highest in 9 years. The average interest rate for 30-year mortgages was up 1 basis point to 4.75%. That average is different from the non-seasonally adjusted calculation from Freddie Mac which is at 4.45%.

(Click on image to enlarge)

Q1 2019 - Conclusion

The bad news is earnings estimates are cratering and 2 of the 3 regional Fed manufacturing reports showed weakness.

Philly Fed manufacturing report was strong, but its non-manufacturing report was weak. The good news is investors are probably too bearish on the housing market as the MBA applications index has rebounded in January.

There’s also the possibility that earnings estimates have gotten too low which means they will be soundly beaten. With stocks doing so well in January, that’s already being priced in. I feel that’s too aggressive which is why I’m currently bearish.