Interesting discussion this morning on earnings expectations and subsequent market performance. It seems that after several years of raising estimates, analysts in the current quarter have been slicing and dicing expectations for the quarter:
"When this bull market was young, back in 2003, analysts started doing something unusual. Chastened by regulators’ criticism over the excesses of the 1990s and beaten down by a recession and a bear market, they turned conservative in their profit forecasts. Their initial guesses tended to be too low, and as quarters wore on, analysts would steadily raise their projections, building investor hopes. Then companies, bouncing back from the recession, would stroll in and announce quarterly profits that blew away even the elevated forecasts.
Investors loved it, and in 2003, the Dow Jones Industrial Average rose 25%. The gains continued, at a much subdued pace, in 2004.
Wall Street is all about expectations, and as expectations rise, it gets harder for companies to keep turning in eye-popping results. Last year, the virtuous circle of analyst forecasts began to unravel. As was the case in the hype-filled 1990s, analysts found themselves more often overestimating results at the start of the quarter. Companies began to send out more warnings of problems to come, and analysts began to cut estimates, according to Thomson Financial, which tracks analyst estimates. When companies reported profits, they often beat analyst forecasts — but reduced ones."
The change has been modest, but significant. In January, analysts were looking for SPX Q1 profits to grow at 12.6%. That has since slipped to 11%. The Journal notes the reality of the aging cycle: "Bull markets usually are strongest when they are young, right after a bear market. Investor expectations are low then, and surpassing them is easier. The bull market tends to end, or at least pause, when expectations get well ahead of companies’ ability to deliver."
Note that the mere lowering by analysts may not mean much: "Thomson Financial has found analysts tend to cut forecasts by about three percentage points as a quarter wears on. Then companies have a way of beating the reduced expectations — by about three percentage points."
Bottom line: The bull market is aging, with some of the "excitement and stock surges of its youth" behind it.
Not Very Great Expectations
Amid a Return to Normalcy, Analysts Tame Profit Forecasts;
Possible Sign of Aging of the Bulls
WSJ, March 20, 2006; Page C1
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