A Warning for the Upcoming Earnings Season

earnings outlookThe stock market is a forward-looking animal, always searching for clues about what will happen many months from now. There are hints that things are turning around and the market shoots up. Signs of a slowdown and investors rush for the exits. With earnings season coming up soon, this quarter will be crucial for how the market will perform for the rest of the year.

Earnings season is important for two reasons: reading the reports about what just happened and, more importantly, the earnings outlook for what corporations think will occur for the rest of the year. The key for the S&P 500 is how the earnings outlook compares to what analysts and investors are already expecting. If this earnings season results in the earnings outlook being revised down for many of the S&P 500 components, we will then most likely see a significant market correction.

A market correction occurs when the earnings outlook isn’t represented by the actual results. What matters is the trend. If companies continue to exceed the earnings outlook, this is very bullish. If companies disappoint in their earnings outlook, this is manifestly bearish.

With the S&P 500 up approximately 12% in the first quarter, this the strongest start to a year since 1998. Earnings season coming up will be a key barometer if the expectations are too lofty. One interesting fact: if we take a survey of analysts expectations for the S&P 500 this earnings season without the earnings of Apple Inc. (NASDAQ/AAPL), the average forecast for the first quarter is negative at -1.7%. Last year, earnings were growing at a 16% positive clip; we’re now down to slightly negative numbers for the S&P 500 this earnings season. Considering how high the market is, these are not the ingredients of a manifestly bullish market for the S&P 500.

People often talk of how cheap the S&P 500 market is by looking at the price-to-earnings ratio. However, if earnings decline, then this ratio all of a sudden isn’t so cheap. It gets even odder, as some analysts see earnings-per-share growth exceeding 15% in the second half of the year. I don’t see how this is possible given the higher commodity prices and lean employee staff counts. Companies in the S&P 500 have fired their way to a lean operating machine; however, they can’t fire anymore, and yet some analysts are looking for margins to expand in the third and fourth quarters.

What we will most likely see, in my opinion, are relatively good numbers for the first quarter this earnings season, but poor guidance in the earnings outlook for the remainder of the year. Just as Best Buy Co., Inc. (NYSE/BBY) had a poor earnings outlook, I believe this earnings season will be littered with S&P 500 companies guiding downwards in their earnings outlook.

I recently wrote an article on FedEx Corporation (NYSE/FDX) called What the FedEx Warning Means for Your Investments. While the company had good numbers during its earnings season, the earnings outlook was very cautionary. The firm is grounding and parking planes, as it doesn’t see any growth around the world. I think a similar theme will play out for S&P 500 companies, as the earnings outlook this earnings season is going to be one of caution. As an investor who looks out 12-14 months, this does not sound like a resoundingly bullish sign for S&P 500 companies, especially following one of the best quarters in over a decade.