The 2 Risks I’m Worried About Right Now: Earnings & The Fed

Earnings season is starting. While there are many ways to look at earnings, I like to think of each quarter as its own “Earnings Game.” And right now, we’re just starting the second half of this quarter’s game.

In broad terms, the earnings game splits into two halves of about three months each.

The first half of the Earnings Game is when analysts revise their earnings forecasts. In sports terms, if this was a hurdle race, they would be lowering the bar. At the beginning of the first half, the bar is about waist high. By the end of the half, the bar is just above the ankles.

In the second half of the Earnings Game, companies report earnings. Many companies beat expectations — usually about 75% of those reporting in a quarter. When the stock inevitably clears the low hurdle, the shares jump on the news.

Now, lest you think me becoming cynical as I age, let me put some numbers to the game.

— Over the past five years (20 quarters), analysts reduced their estimates for fourth quarter earnings by an average of 3.3% between September 30 and December 31. The 10-year average is 3.1%.
— Actual earnings reported by S&P 500 companies beat estimates by an average of 4.9%.
— In an average quarter, 72% of companies in the S&P 500 beat expectations.

In the most recent quarter, analysts lowered their estimates for earnings per share (EPS) of the companies in the S&P 500 by 4.7%.

We are now at the halfway point of the Earnings Game — the part of the game where companies start to report actual results. I’ll update you of those results throughout the quarter, but I’m happy to give you my prediction now: For the quarter, I expect more than 70% of companies to beat expectations, and I expect those stocks to rally.

As for the companies that miss expectations? I expect those stocks to sell off sharply. That’s why I tend to avoid holding open positions in companies on the day they report earnings. The risks are high, and, as I’ve mentioned before, I am risk averse.

And while we’re on the topic of risk, there’s something that I’m worried about as we begin the new year: the Federal Reserve. Let me explain…

The Fed Has Me Worried

Want to know the scariest words I know?

“Okay, Mom.”

That’s because when my children all agree with me, I know there’s a problem.

When everyone agrees with me, my mind starts racing to figure out why. Did I possibly misspeak and actually tell them ice cream was “fine for breakfast” when I really meant oatmeal? Or — and this is the more likely answer — have they hatched a hare-brained scheme and think they have a great plan to deceive me?

As you can guess, my kids have taught me to be suspicious when everyone agrees with me. After reading the economic projections released at December’s Federal Reserve meeting, I’m thinking I should send my kids to intern at the Fed. Someone needs to teach those bankers that the time to be most vigilant is when everyone agrees.

The chart that caught my attention is the data from the familiar dot plot. The latest dot plot is below.

Source: Federal Reserve

The dot plot shows each Fed official’s forecast for the federal funds rate. Each dot represents one Fed official. A dot reflects what each U.S. central banker thinks the midpoint of the fed funds rate will be at the end of each year. Dots are shown for the current year and three additional years.

As you can see in the table above, all 17 officials expected rates to be unchanged for the remainder of 2019. For 2020, 13 of the 17 officials expect no change and 4 expect a single quarter point increase.

The next table presents the data that underlies the dots. It shows how much policymakers agree about the next 12 months.

Source: Federal Reserve

It wasn’t always this way. Last year, there was less consensus.

Source: Wall Street Journal

[Related: The Fed’s Dangerous Game — And What You Can Do About It]

What All This Means

Here’s my point…

Diverse opinions can make the Fed better. I’m worried that with such widespread agreement about the coming year, officials may be slow to react to the unexpected events that seem inevitable to me.

That’s because I see 2020 as an election year in United States as well as the year when Brexit is either completed or abandoned in the U.K. Both of these events will affect the European Union, as both issues are closely tied to trade. It’s also likely to be a significant year for China, which faces rising unemployment, slowing economic growth, and an increase in bad debt. The U.S. election is likely to be a factor in China as well.

Overall, I see a lot of risks. That’s why I’m even more surprised to see the Fed acting like we will calmly sail through 2020. This is one time where I think my kids could teach the Fed that the time to worry is when you think everything is calm.

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