Are We Experiencing a Correction or a Major Bearish Reversal?

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Are We Experiencing a Correction or a Major Bearish Reversal?

Daniel Cross Feb 29, 2016

Interpreting Earnings Reveals Concern for Investors

The two main culprits for the decline are energy stocks, which fell 74% in the fourth quarter and expected to fall 93% in the first quarter, and the strength of the U.S. dollar. Out of 30 companies listed in the DJIA, 11 provided revenue growth numbers from Europe, and nine of those showed a year-over-year decline. Companies that derived most of their revenue from overseas sales fell 11.2% in the fourth quarter.

Corporate guidance doesn’t paint a profitable picture for the first quarter either; 88 companies have issued negative guidance, while just 22 issued positive guidance. Energy and materials led the index for year-over-year declines, while health care and telecommunications were the largest gainers. Surprisingly, a large percentage (69%) of companies reported higher-than-expected earnings. Overall, however, earnings upside surprises are still coming in short of the five-year average – 3.7% higher compared to 4.7%.

Despite the continued drop in earnings and stock prices, the average forward P/E ratio is still higher than the five-year average at 15.7. That tells us that there is still further possible downside just to reach the average valuation levels of the S&P 500.

The news isn’t all negative, though. Lower energy prices should prove to benefit certain companies – especially those in the transportation sector. A fall in the U.S. dollar would also help boost earnings by reducing losses from foreign currency exchanges.

The Bottom Line

80% of companies issuing guidance are negative – above the historical average of 72%. Analysts don’t expect overall earnings and revenue growth to become positive again until the third quarter. For the year as a whole, earnings are expected to grow a total of 2.8%, while revenues are expected to increase 1.9% year-over-year.

We can expect the first half of the year to see high volatility and further declines, but after the summer months, we might finally start to see a recovery and bullish sentiment to return to the markets.

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