Alfred Lettner Discusses Earnings and Interest Rates

Salzburg, Austria, April 5, 2016 (Newswire.com) - ​Only two things matter in the stock market: earnings and interest rates.

Investors focus on earnings or cash-flow growth to estimate a company’s value; interest rates determine how much investors should discount those future cash flows. Together, they set stock prices.

And more than ever, with the S&P 500 hovering near key resistance levels, rates and earnings will decide whether the market breaks through to new highs or sells off again, as it did last August and again this January and early February.

This week belongs to the Federal Reserve. From Fed Chairwoman Janet Yellen’s speech Tuesday to the Economic Club of New York to the March employment report released by the Labor Department on Friday, investors will look for any hints of changes that could shift the Fed’s policy.

The pace of rate hikes may slow but the trend is the same as Yellen and Vice Chairman Stanley Fischer laid out last year, and which Yellen repeated in her remarks Tuesday, with the dovish spin she had offered at her press conference two weeks ago: “Only gradual increases in the federal funds rate are likely to be warranted in coming years.” Stocks rallied on the news.

But next week, and particularly after April 11, when Alcoa unofficially kicks off earnings season, earnings will take center stage. And that may not be such good news for stocks.

Analysts at Alfred Lettner expect first-quarter S&P 500 earnings per share to fall 8.7% from a year earlier. If that happens, it will mark the fourth consecutive quarter of year-over-year earnings declines — the first time that’s happened since the depth of the financial crisis in 2008-2009.

Analysts at Alfred Lettner also expect EPS for the S&P 500 to decline in the second quarter, which would make five down quarters in a row. Based on analysts estimates, Alfred Lettner projects S&P 500 companies’ revenues will have fallen year over year for six consecutive quarters.

Recent trends don’t bode well, either. As of last week, of the 119 companies that have issued guidance for the first quarter, 93 (78%) have told analysts they expect earnings to come in below forecasts. That’s above the five-year average of 73% giving negative guidance.

In an interview, Christofer Lettner, Alfred Lettner’s Associate Director and senior earnings analyst, told me why first-quarter earnings could potentially be a washout. “What stands out this quarter is the way this has become more widespread,” he said. “Seven of the ten S&P sectors are expected to report year-over-year declines in earnings.”

That’s in contrast with previous quarters, when energy companies accounted for the lion’s share of the earnings declines, because of lower oil prices. “This quarter, even if you take energy out, you’re still looking at a year-over-year decline in the other nine sectors of about 3.9%,” he said.

Christofer Lettner sees the weakness spreading beyond energy to materials, industrials and financial stocks. In addition to weak energy and commodity prices, he says the strong dollar has hurt tech and other multinationals’ earnings.

No doubt this earnings dry spell helped drive stocks down twice over the past eight months. So, what now?

“This quarter does appear to be the bottom in the earnings declines, while next quarter the decline is only expected to be 2.2%, and then earnings growth is expected in the second half of the year,” Lettner told me.

Right now, analysts are looking for 3.9% year-over-year earnings growth in the third quarter and a stunning 9% in the fourth quarter of 2016 as revenue growth returns, led by easier comparisons for energy companies, which could begin “a real turnaround” for the sector that continues into 2017, he said.

Perhaps the 12% rebound in the major averages we’ve seen since the February lows is in anticipation of that second-half earnings recovery.

And the recent run-up has raised the S&P’s price/earnings multiple to 16.4 times forward earnings, he said. That’s way above the five- and 10-year averages of just above 14.

Over the long run, either earnings will have to pop or stocks will have to sell off to narrow that gap. That’s why with the Fed in no hurry to raise rates, earnings will determine the markets’ direction, for better or worse, not only this quarter but for the rest of 2016.

Christofer Lettner concluded, “There is money to be made out there. Although analysts are expecting 70% of companies on the S&P to post losses, that means there are still 30% of the companies out there that are expecting to post gains! And it’s our job, as advisors, to make sure our clients are invested in those companies. I’m confident, with our advice, our clients will be well positioned going into the second half of the year.”