Corporate earning season is Wall Street's version of the NFL and NBA drafts. Except in cases where a company wildly misses or exceeds earnings expectations, the most important information from the earnings' reports is the company's future expectations. Yes, a company that doesn't meet its earnings will be punished, but it is what its report says about its future performance that gets the most attention on Wall Street. For traders, these reports collectively give the true state of the economy. Unfortunately, this quarter's reports suggest the economic downturn is accelerating.
At first blush, this quarter's earnings reports were decent. Two-thirds of the companies reporting earnings so far have met or beat analysts' expectations. But, at the same time 6 out of 10 companies missed expectations on the top-line revenue number. So, while their profits may be okay, their overall-sales are down. Its a clear sign that the economy is slowing.
Companies have a lot of tools or "tricks" to maintain their profits. For example, Exxon reported record earnings this quarter, but more than half their earnings were from asset sales. Without these sales, their earnings would have fallen from last year. These tools can work in any particular quarter, but in the face of falling sales--again reported by 60% of companies so far--they become less effective. To maintain profitability in a time of falling revenue, companies will be forced to trim costs and become more productive. That usually translates into job losses.
Remember, revenue, more than earnings, reflects the overall strength of the economy. That so many companies, across industry sectors, are reporting lower sales reflects a broad pull-back in the economy.
Worse, even many companies who met earnings and revenue targets have lowered their expectations for the rest of the year. Caterpillar, who beat on both earnings and revenue, lowered its guidance on revenue for the rest of the year. The company is still bullish on its ability to hit profit targets, but lowering its revenue expectations is a sign it expects a tougher economic climate.
Extrapolate this across hundreds of companies, and this lowered guidance gives an idea of the economic head-winds our economy is facing. Wall Street is hard-wired to be optimistic about the economy. Their business, after all, is predicated on millions of people investing money in hopes of a future return on that investment. Shrinking revenue makes those returns more elusive. It also suggests the current economic pull-back will pick up steam in the coming months.
It seems our economy was on a sugar-high at the start of the year. The headaches are now settling in.