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Wall Street's grand earnings charade is about to happen again (SPY)

Published by Business Insider on Mon, 13 Jul 2015

Earnings season is here, and Wall Street is expecting a bad quarter.The forecast is for a 4.4% year-over-year decline in second-quarter earnings, according to FactSet.But when compared to Wall Street's own expectations, earnings will probably seem fine when all is said and done.In a note to clients Sunday, Deutsche Bank's chief US equity strategist David Bianco called this "another 'fish hook' earnings season."That is, a familiar pattern is about to repeat itself: Analyst expectations for earnings growth plunge into reporting season, and then companies beat these lowered expectations as we go along. As a result, things don't look as bad as they once seemed and everybody goes home happy.Bianco wrote that there's definitely a better way to measure whether a company crushes the quarter (emphasis added:)The recurring "fish hook" patternin quarterly bottom-up S&P EPS pre and post reporting is a charade, leading tocommon but specious stats that two-thirds of companies beat estimatesusually by a 3% weighted average. For this reason, we have long stressed theirrelevance of judging earnings season by meet/miss ratios or the averagebeat. We focus on y/y EPS growth with an eye toward operating measures thatexclude litigation and indicate underlying growth such as y/y sales growth. Onthis basis, S&P EPS growth is weak this 1H and most of the past few years.The forecast for S&P 500 earnings per share in Q2 has been cut 2.3% since March and the 4.4% expected decline we noted is precisely this number. Excluding the energy sector (which has been hiked 12% due to the rebound in oil prices,) EPS expectations have been slashed 3%, matching the historical average.Last earnings season, the energy sector provided a great example of the point Bianco is making here.We highlighted the "single biggest surprise"of the year at the time, which was that the energy sector had the biggest EPS surprise rate.After the oil crash, analysts put forward all the worst-case scenarios for earnings and sales. But companies reported better-than-expected results, and the energy sector had a 22.4% surprise rate, versus 6.3% for the S&P 500, according to UBS.But year-over-year, energy sector earnings were the worst.And so here's Bianco's chart, showing the "fish hooks" that we'll keep an eye on as Q2 earnings season gets rolling:SEE ALSO:This is 'the most embarrassing thing to say as an analyst'Join the conversation about this storyNOW WATCH: Here Are 5 Big Things Paul Krugman Says He Got Wrong Over The Years
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