Thursday, July 7, 2011

Earnings: Société Générale's Albert Edwards On Why "The Farce That Is US Reporting Season" May Be Different This Time (July 7, 2011)

From ZeroHedge:
As everyone who follows earnings seasons knows all too well, one of the traditional games companies play with sellside research analysts is to push earnings estimates lower just ahead of earnings announcement only to beat by the thinnest of margins, setting off a buying rally in the stock that more than offsets the gradual decline it may have experienced in the preceding run down.

This observation is one half of Albert Edwards' note to client from this morning. He says: "It’s that surreal time of the quarter, just ahead of the reporting season, when US companies cajole compliant analysts into reducing their profit forecasts so that on the day the company can record a positive earnings surprise. Companies place so much store on beating analysts’ estimates that they play this ridiculous game of guiding down analysts numbers in the weeks or even days ahead of the announcement, only to beat depressed forecasts by a penny on the day (see chart below).

The angle in the press and in analysts’ reports is then that this constitutes ‘good news’ despite, more often than not the outturn undershooting the market estimates of only a few weeks previous. Nuts!" The other half focuses on how this particular earnings season may be different, and why unlike previously, earnings downgrades may be for real this time: "We show that in contrast to expectations of a second half recovery, economic leading indicators are actually signalling the reverse, as is our favoured measure of analyst optimism.

Hence the recent spate of profit warnings – which have resulted in a deeper than normal round of downgrades – may be the beginning of something far more  undermining to equity prices over the next six months." So is this time, especially in the absence of the artificial boost to everything that is QE, any different? With earning season imminent, we will finally find out just how well the corporate sector (not having represented the actual economy for a long time) can stand on its own in the absence of monetary fiscal and stimulus for the first time in years.

Edwards' graphic presentation of the "reporting season farce":

His explanation:
In early May, prior to the renewed jitters about US economic slowdown, we pointed out that analyst optimism seemed to be turning down (albeit from a very high level), and that this was probably a prelude to worse than expected economic data. We have updated that chart and it shows optimism has deteriorated further and that the change in optimism has fallen deep into negative territory (see left-hand chart below). For a more timely reading of the profits situation, my Quant colleagues aggregate the data from the company level on a weekly basis (see righthand chart below). Both at the US and global level this shows analyst optimism falling away more sharply than it did prior to the previous report around three months ago).