Earnings forecasts are a risky tool in our bag. There was a story in Bloomberg this morning (January 10, 2019) discussing how “profit forecasts are being cut like it’s 2009”
I have a few thoughts on earnings forecasts, and then we will get to where this affects me and you.
1. Companies have to determine whether their business is slowing or growing. Only then will that information get shared with analysts. Profit forecasts/earnings estimates will always be late.
2. Many companies began scaling back their earnings projections during the third and fourth quarter last year (2018) because there is no clarity regarding trade and potential tariffs. These firms have no visibility, so they must be cautious. Slowing growth in China, dropping prices of oil, uncertainty in Europe: all nothing new and each were the primary figures to blame behind market swoons in 2011 and also 2015-16.
This leads to what some have called an “earnings slowdown.” Is it a recession? No.
Profit forecasts at mid 2016 (heading in to 2017), were showing double-digit earnings increases into 2018. This is one reason why the market went up steadily throughout 2017 – in anticipation of good earnings in 2018.
The earnings forecasts now still show good growth for the S&P 500 – showing earnings gains of over 8%. Again, it’s only a forecast. But the forecast is less than the earnings growth seen in the previous twelve months. The market needed to “ratchet things down” to bring valuations more in line with expectations.
3. What if a “trade war” vanishes? What is “Tariff Man” decides tariffs are bad for business? What will happen to earnings forecast then? What will happen to the market?
Unfortunately, the market tends to “re-price” itself pretty quickly. We remind clients the market climbs the stairs on the way up, but takes the elevator on the way down. Compared to a climbing market, market drops are usually swifter and can be painful to watch.
Now, this is where you and me step into the picture:
We don’t like writing about earnings forecasts very much, because we find them to be flimsy and often subject to change too often. They’re unreliable.
The main thing to do during market drops is not to lose your head, not let emotions take control. It’s easier said than done. We had a 29 year old last week ask me what “we were doing to hurry up and get defensive?” I reminded him this is money he is setting aside for retirement – a point in his life that is easily thirty years away (or longer).
I also reminded him he should be begging to buy more things on sale.
Seeing 600 point and 800 point drops can turn normal folks crazy. In the right circumstances (for someone with the right temperament), I let them know “if the market continues to drop 600 points per day, the Dow Jones will be at zero in 38 days” (some time in March). It’s not a trend that continues forever.
Market drops can be like a forest fire. These fires need lots of dry kindling, along with oxygen to sustain and grow. The hardest thing to do is step aside and let the market do its’ thing. Don’t feed the frenzy.
The biggest issue we see (from our side of the desk), is clients who are “betting the rent” with the market. Essentially, they are playing with money they truly cannot afford to lose. Those folks, those assets should never have been in the market to begin with. Fortunately, we do not have many that “roll the dice” that way, and we are quick to dismiss folks who we discover have been betting the rent. We are just not a good match for them.
We discuss financial planning all the time with our clients. It’s a shame that some clients take the financial planning process seriously, some do not. One big reason behind these exercises is it can help US (as your adviser) determine the proper amount of risk a client ought to be taking.
Sadly, we hear from a small number of folks only when (in their minds) their house is on fire.