The Independent Market Observer

4/25/14 – Confidence and Earnings

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Apr 25, 2014 1:30:00 PM

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Consumer confidence will play an increasingly important role in supporting stock prices as earnings show signs of rolling over.

The other day, I wrote about how the price/earnings multiple is strongly correlated to the level of consumer confidence. It makes sense: The more confident people are about the economy, the more sure they will be that earnings will grow—and the more they’ll be willing to pay for any current level of earnings.


Looking at the chart, you see something of a gap between consumer sentiment and stock prices, which is troubling. But today’s figures suggest consumer confidence has moved back up, to a nine-month high, which should provide some support.

This matters, because even as confidence continues to grow, earnings growth is deteriorating. Despite good news from some fairly high-profile companies, the overall tenor is downbeat. Here are some of the details as reported by FactSet, as of the end of last week:

  • The percentage of companies beating estimates is below recent averages.
  • Earnings actually declined for the quarter so far, for the first time since the third quarter of 2012.
  • 60 percent of companies that have issued guidance for the second quarter have been negative.
  • Revenue growth is now below what was expected at the end of March.

You can, justifiably, blame much of this on the weather, and that is what companies are doing. Expectations for future earnings growth remain high, at double digits in the second half of the year, suggesting that investors are buying the weather story.

These numbers should change in the next week or so; the results of the 161 companies that have reported this week may make a positive difference. Even if they don’t, rising confidence—and the apparent belief that the weather is to blame for much of the current earnings weakness—may limit any damage.

At the same time, the high level of future expectations against the current growth level suggests that risk levels will remain relatively high for the rest of the year. It’s hard to see what the catalyst might be to push earnings growth up to the expected levels, and investors should be cautious in pricing the market against that expected growth.

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