This week marked the start of the United States March quarter earnings reporting season. As is usually the case, both analysts and companies have “aired their dirty laundry” early, with particularly large downgrades to expected earnings well ahead of time.  As a result, it’s quite likely that the actual reporting results may once again be “better than expected”, which could provide some relief to Wall Street.  That said, the challenging earnings outlook for the US market – and hence for global equities in general – has not changed.

Earnings Reporting “Game” Alive and Well

In what is one of the hallowed traditions of Wall Street, the “confessions season” is a time when both company management and analysts both tend to downgrade a firm’s expected earnings (if necessary) ahead of the scheduled quarterly earnings report.  In this way, it allows companies to put a positive spin on even a bad result, as it might “fortuitously” at least match or even beat “market expectations”.

Indeed, over recent years, the average upgrade to expected year-on-year growth in quarterly earnings during the reporting season has been around 3%.

The latest confessions season is no exception. According to analysis by FactSet, of the 121 companies that have issued March quarter earnings guidance, 94 – or 78% –  provided negative guidance. That is the highest number of negative guidance warnings since the December quarter 2013, and the second highest overall since FactSet began collecting such data in 2006. At the same time, analysts have slashed their earnings expectations: Q1 earnings are now expected to fall by 9.1% on year-ago levels, compared with expected growth of 0.7% at the start of the year.

Allowing for the average upgrade to expected earnings growth during the reporting season, this suggests actual earnings will be down around 6% on year-ago levels – the fifth consecutive decline in quarterly earnings from year-ago levels.

Earnings Weakness not Just Confined to Energy

Although earnings downgrades were most extreme in the energy sector (reflecting lower oil prices), expected Q1 earnings have been downgraded across all 10 industry sectors so far this year, with material and financial stocks also suffering particularly heavy downgrades.  Indeed, 7 of the 10 key industry sectors are expected to post actual quarterly earnings declines on year-ago levels.

The above analysis is consistent with the pace of financial-year earnings downgrades evident from Bloomberg data.  As seen in the chart below, expected earnings for 2016 and 2017 have been consistently downgraded in recent months, such that forward earnings* have essentially tracked sideways over the past year.

 Weak Earnings leave Valuations Stretched

All up, given current still elevated valuations, and a likely flat earnings outlook, the US equity market may well face another year of sluggish performance.