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Looking backward to see the future

Luis Hernandez

Happy Lunar New Year!

It’s officially the Year of the Pig!

I have always been a little confused about the Chinese Zodiac. I’ve read the descriptions on the placemats at Chinese restaurants like so many others.

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But unlike the zodiac that appeared in my local newspaper, the Chinese Zodiac focused on character descriptions rather that predicting daily events.

It was the fortune cookie that predicted the future. Well, sort of.

Many investors may not think of themselves as trying to predict the future, but they are.

When you buy a stock looking for growth, you’re “predicting” that the company will do well, and other investors will rush in to value the stock appropriately. When they do, the value of your shares will go up.

Sometimes it feels like predicting the market can be easy.

After the single worst December since the Depression, it was not difficult to predict that many stocks were oversold and that a rally would be forthcoming.

But I don’t think many predicted such a crazy strong comeback! The market just had its best January since 1987!

But all of that was really before earnings season. About half the S&P 500 have reported Q4 earnings, so, what can we say about how things are going?

John Jagerson and Wade Hansen, editors of Strategic Trader , helped by providing some big numbers for how the market is doing this season as we have reached the halfway point.

They’ve been trading in the markets for more than 20 years, and they specialize in making difficult market concepts easy to understand.

They sent an update to their subscribers this week summarizing earnings season so far, and they made some predictions for the 2019.

  • Of the S&P 500 components that have reported quarterly numbers, 62% have reported positive revenue surprises, and 38% have reported revenue below the consensus estimate.

  • Of the S&P 500 components that have reported quarterly numbers, 70% have reported positive earnings surprises, 7% have reported earnings in-line with estimates and 23% have reported earnings below the consensus estimate.

OK, those sound like pretty good numbers so far, but let’s remember that earnings reports are always looking backward. Now let’s try to predict the future. Here are the numbers John and Wade shared with their subscribers.

  • Out of the nearly 250 S&P 500 components that have reported quarterly numbers, only 42 have issued earnings guidance for Q1 2019. Of these, only 9 companies have issued positive earnings guidance, while 33 companies have issued negative earnings guidance

  • Analysts expect revenue growth to decelerate during 2019. The blended revenue growth rate for Q4 2018 is currently 6.6%, but analysts are forecasting the following revenue growth rates for the coming quarters:

    • Q1 2019: 5.7%
    • Q2 2019: 5.1%
    • Q3 2019: 4.9%
    • Q4 2019: 6.0%

These aren’t terrible numbers, but they are not as good as we saw during 2018.

  • Analysts expect earnings growth to not only decelerate during 2019 but also turn negative in Q1. The blended earnings growth rate for Q4 2018 is currently 12.4%, but analysts are forecasting the following earnings growth rates for the coming quarters:

    • Q1 2019: -0.8%
    • Q2 2019: 1.6%
    • Q3 2019: 2.7%
    • Q4 2019: 9.9%

These numbers are a far cry from the double-digit earnings growth rates we have become accustomed to during the past five quarters.

In general, many analysts are concerned expenses — especially interest expenses (since rates have been rising) — are going to be increasing. This will impact EPS. They are also anticipating a reduction in share buyback programs in 2019 compared to 2018. This will also impact EPS since there won’t be as large of a reduction in shares.

OK so we’ve had some revenue beats and earnings beats reported for Q4, and that has certainly given this market a boost, but the numbers for the next quarter are looking like a big slowdown.

We all understand that estimates are just that – estimates. No one can really predict the future, but we can at least try to get a sense of which way things are trending.

John and Wade provided some great context for all this by focusing on the technology sector. Here is more from their latest Strategic Trader update.

The strong earnings beats in this sector made traders realize they pushed Information Technology stocks down much too far during Q4 2018 and that a bullish correction was needed.

However, this bullish correction hasn’t even pushed Information Technology stocks back up to their early-December 2018 highs, let alone their early-October highs – as you can see in the SPDR Select Sector Technology Fund ETF (XLK) chart.

Part of the hesitancy traders are feeling about pushing Information Technology stocks higher stems from the expected earnings growth numbers for the sector.

While the sector has enjoyed the largest percentage of earnings beats of any sector for Q4 2018, it has the lowest expected earnings growth numbers of any sector for Q1 2019 (see figure below).

This doesn’t mean Information Technology stocks can’t continue to climb this year – especially if expectations change – but it has forced traders to be more cautious than they were during late-2017 and most of 2018 when earnings growth was accelerating by leaps and bounds.

Bottom line? As strong as the earnings growth season has been so far, forward looking numbers have been weak.

Predicting the future is dicey because of all the mitigating factors. There is still a lot of uncertainty about Fed rates, government shutdowns, Congressional spending, treasury yields, and even the status of negotiations with China.

Imagine if there had been no announcement about China trade talks today ….

Here is what John and Wade think…

We anticipate the majority of companies that are yet to report their Q4 2018 will beat estimates, which should keep the current bullish bounce going, but we don’t expect the S&P 500 to break above 2,820 unless future growth estimates start to pick up…

Investors should watch for that 2,820 number to determine if the next market breakout is around the corner.

To a richer life…

Luis Hernandez, Managing Editor
and the research team at InvestorPlace.com

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