More Volatility Ahead: Revenue Expectations for Companies of the DJIA for Q3 2015

March 17, 2015 By Nicholas Colas

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Summary: Equities discount fundamentals two quarters ahead, at least according to one old-time market aphorism.  Today we test that theory by looking at revenue expectations for the companies of the Dow Jones Industrial Average for Q3 2015.  After all, if the strength of the dollar is really going to crush the fundamentals of big multinational companies that is where we would see the vise squeeze most firmly – in July 2014 the euro was still at $1.37. A look at brokerage analysts’ estimates for Q3 shows that revenue growth is, in fact, teetering between growth and contraction. The headline number calls for an average 3.4% decline between last year’s revenues and this year’s Q3 for the Dow companies.  Exclude the energy names (where the Street expects to see revenues decline by close to 50%), and the average revenue growth for a Dow name should be all of 0.8%. Just two months ago, the Street thought it would be 3%.  King Dollar may be powerful, but he exacts heavy tribute. Bottom line: more volatility for U.S. markets ahead. 

Since the beginning of 2015, the S&P 500 has closed up on the year 25 times, but down on the year in 27 instances.  As they say in NASCAR, however, it’s not how you run but how you finish that counts.  Today’s rally put the S&P back in the black for the year to the tune of 1.1%.  It just took a rally of 1.4% to get us there. But even that statistic is a tad misleading, for the Index hit 2091 on December 29th of last year; if that had been year-end we’d still be down in 2015. 

Unlike the famous saying about the paternity of success and failure, the stagnant U.S. markets can lay claim to many parents.  For example, the plummeting price of oil threatens the energy sector, a reliable job creator and source of earnings growth over the past 5 years.  Also, the most popular trade among trend-following retail and sophisticated institutional investors alike is the same: out of the U.S. equity markets where the central bank is tightening and into Europe and Japan where they are easing.  Just don’t forget to hedge the currency risk…

The alpha male in this gaggle of reluctant “Baby daddies” is, however, the strength of the U.S. dollar.   After living comfortably for years at $1.30 to $1.50, the euro looks ready to go to $1.00. The Japanese yen used to happily trade near parity with the penny in 2013 and the first half of 2014; now it trades for 120 Yen to the dollar.  All this is good news if you are an American citizen looking to buy a nice fixer-upper castle in Burgundy.  Those are thick on the ground for less than $2 million U.S. Links here and here

If you run a U.S. multinational company, or own its shares, however, “King Dollar” is proving to be a bit of a tyrant. And it’s not like you are unused to fundamental challenges, after all.  The U.S economy is OK (but not great), the situation in Europe is what sports fans call a “Rebuilding year”, and former headlining stars like the Chinese, Brazilian or Russian economies are doing dinner theater in Tunica MS and dreaming of a comeback tour. 

But the recent strength in the dollar is something different.  It may not be as transitory or cyclical like the other challenges noted here. After all, the European Central Bank has promised 2 years of bond buying, and the U.S. Federal Reserve is doing its best to convince global markets that it will increase interest rates this year.  If rule #1 of trading is “Don’t fight central banks”, the difference in these two approaches is likely to keep the euro on the back foot for a long time. 

We see the pressure a stronger dollar may have on U.S. corporate fundamentals as we look at the expectations Wall Street has for revenue growth among the companies of the Dow Jones Industrial Average.  We’ve done this analysis every month for the last few years as a proxy for expected growth in the U.S. and global economy.  Now, however, the data tells a richer story about the effect of currency volatility on U.S. public companies as well. 

We’ve included several charts and graphs with the complete dataset below and here are the key takeaways:

  • The current quarter will show negative revenue comparisons to last year’s Q1.  On average, Wall Street is looking for a 2.4% decline in sales for the Dow companies in this quarter.  Back out the energy names – Chevron (expected down 48%) and ExxonMobil (down 50%) – and the expected comp is +1.0%
  • Analysts are taking the pruning shears to their Q2 and Q3 expectations.  For Q2, the average Dow company now has an average expected revenue decline of 3.4%; it was still positive 0.5% just 60 days ago.  For the third quarter of 2015, analysts are now looking for average revenue growth of negative 1.9%, down from +1.7% 2 months ago.
  • It’s not just the energy names dragging down these numbers.  Excluding CVX and XOM, analysts still show an average Dow revenue growth pace of negative 0.1% for Q2 and just +0.8% for Q3.  Two months ago those were +2.2% expected year on year expansion for Q2 and +2.9% for Q3 2015.
  • So how much of this is baked into stock prices?  Hard to say, but the Dow currently trades for 17.5x projected 2015 earnings.  Take out the energy stocks, which trade at 26.9x (CVX) and 22.2 (XOM), and the average earnings multiple falls a touch to 17.0x this year’s earnings per share.  That might sound expensive relative to historical norms, but the Dow pays a 2.0% dividend – about the same as a 10-year U.S. Treasury and much more than any Eurozone sovereign except Greece. 

From working as a brokerage firm analyst for many years, I can provide two additional pieces of color to this analysis. 
First, the Street doesn’t slash revenue or earnings numbers just because a currency is moving – even the dollar.  Look at our table and you’ll see many companies with significant currency sensitivity where published estimates are either flat month over month or only slowly trending lower.   There are clearly more cuts to come. Second, analysts will shift their earnings estimates to later quarters to avoid cutting full-year numbers. That means we could be looking at revenue and earnings revisions lower for much of 2015. 

The bottom line here is that U.S. companies are facing a new headwind, in the form of a dramatically stronger dollar in 2015, which compounds the challenges they already have.  Yes, they might hedge some of their expected operating income from the Eurozone so the impact on earnings may be manageable.  Still, no company hedges for revenues so the impact on sales growth will be fully visible.  The good news is that this is not a surprise anymore.  The bad news is that we may see a lot more flip-flopping in U.S. stock markets and investors work out what these pressures on the top line mean to valuations and earnings fundamentals. 

And now, for those castles…

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Nicholas Colas

Nicholas Colas

Nicholas Colas is Chief Market Strategist for Convergex.

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