Nick Raich on Earnings Guidance

I recently attended an economic luncheon a few weeks back where the guest speaker was Nick Raich, Director of Research at Key Private Bank.  Mr. Raich who is a frequent visitor on CNBC (see video below for his latest appearance and presentation from economic meeting) is a big proponent of following earnings estimates specifically the spread between earnings estimates.  Raich believes that this spread is a key indicator which drives asset prices.  Expectations up, "risk on", expectations down "risk off".


Analysis and commentary from Nick

• The good news: 
• More improving domestic economic data 
• 76% of  companies reporting last week exceeded estimates 
• Don't fight the Fed(s) 
• Bad news is being overlooked 
• Near-term (1Q and 2Q 2012) expectations are very low 
• With the LTRO, the chances of a Lehman--type event occurring in Europe are very low (but not zero either) 

• The bad news: 
• Bad news is being overlooked 
• 65% of the companies that have reported 4Q 2011 earnings had to lower their 1Q 2012 outlooks (9 out of 10 S&P 500 sectors have seen their earnings outlooks lowered) 
• Don't confuse better U.S. economic data with S&P 500 profits 
• The S&P 500 is a global benchmark and its declining profit expectations are partly because of European austerity 
• Could all the stimulus begin to turn into poison (rising velocity of money, increased wages, etc = inflation)? 
• To justify the price rise, 2013 estimates were raised rapidly and we are now starting to hit that brick wall, setting the stage for more downward revisions - will the market care though? 
• A disorderly Greek default cannot be ruled out - it's just not likely at this point 
• Rising tensions in the middle east 

Along those lines Bespoke had a similar piece on how earnings guidance has been trending and the news is not good.

• So companies as a whole have had a tough time living up to analyst expectations for the fourth quarter, but how does forward guidance look?  Just as bad.  Below is a chart showing the spread between the percentage of US companies that have raised guidance minus the percentage that have lowered guidance this earnings season.  As shown, the number currently sits at -3.3 percentage points, meaning more companies have been lowering than raising guidance. 

As Nick pointed out in his interview we had had two quarters in a row where companies have beat earnings but lowered guidance as the markets have screamed higher.  To me this is just continued evidence to take a conservative defense approach to portfolio management right now.  Even though our fund's short positions have not worked out yet this year it at least gives us some downside protection as we prepare for our first 1% down day of 2012.