The Outlook for United States Corporate Earnings
Kalinowski, Joseph S., The Journal of Business Forecasting Methods & Systems
Last month marked the second anniversary of the market top and the first anniversary of the economic slowdown. Thinking back, it somehow seems like eons ago when the internet was still written with a capital "I," much like God, and the financial world had gravitated more toward its spiritual side and away from its morose quantitative side. A time when people en masse seemed to develop a peculiar and profound disregard for basic economics - let alone grade-school arithmetic.
Every generation gets fooled once - but learns its lesson the hard way. While this probably means another 15 years will pass before we see anything approaching what we saw in the 90s, it might likewise mean that we won't suffer horribly either. There is life before and after bull markets.
Recent data indicate that analysts' corporate earnings forecasts are closer to the mark than they have been in the past two years - as the excesses of the late 1990's have finally been burned off. Wall Street analysts have spent the last six quarters reining in those overly optimistic forecasts, and corporate managers have been equally busy. In fact, 2001 will go down as one of the worst years in terms of earnings deterioration since our records begin in 1979. Analysts slashed their forecasts by nearly 25% from start to finish of last year - in 1982, the second of the twin recessions brought forecasts down a record 29%. While this economic recession may prove to been a mild one, the profits recession was one of the worst on record -- with at least six quarters of year-over-year declines in earnings for the S&P 500 (the record was five consecutive declines in quarterly earnings from 4Q69 to 4Q70).
The US economy was saved by the undaunted consumer. While the business sector had to work off its inventory and cut costs in the form of capital spending and labor, the consumer found that stimulus in the form of monetary and fiscal policy, lower energy prices, and not buying stocks freed up money for other things. Even the deadliest attack ever on American soil did not dent the average American's propensity to consume. The collapse in corporate earnings was largely a result of a meltdown in technology and telecommunications as opposed to say a collapse in real estate, the banking industry, or an oil crisis - and a general feeling of despair was never felt. In rather amazing fashion, the economy's resilience closely paralleled, if not mirrored the nation's resilience.
Corporate earnings have been watched closely by economists and strategists during this latest earnings cycle, which is why we feel it relevant to express our views that the washout occurred in 4Q01, with emphasis on the fact that the quality of forecasts have improved dramatically - as measured by two critical trends: corporate pre-announcements and earnings deterioration.
As of March 20, Thomson Financial has collected 742 total pre-announcements for 1Q02, of which 218 (29%) have been positive, 359 (48%) have been negative, and the remaining 165 (22%) are those comfortable with current consensus. It is worth noting that since 1996, positive announcements have made up 19% of the total whereas negative announcements made up 57% of total. The numbers indicate that we are currently getting more good news and less bad news hitting the street for 1Q02.
This phenomenon can be seen in our guidance ratio (number of negative preannouncements divided by the number of positive pre-announcements). The current ratio stands at 1.65 for the US universe. The ratio is lower than any comparable post-- Regulation FD period and the post-Regulation FD average of 3.01. Remember this ratio hit a high point of 5.29 at this time in 1Q01.
We measure earnings deterioration for each quarter as a percentage change in the bottom-up EPS estimate over 150 days starting with the month prior to the beginning of the quarter. For example, 4Q01 data incorporates the EPS forecast from Sept. …