Paul Hickey is co-founder of Bespoke Investment Group and Bespoke Market Intelligence. Bespoke provides research and advisory services to institutional and individual investors. The firm's research is among the most sought after and respected in the investment community. Hickey is frequently seen on CNBC, Bloomberg and CNN, and the firm's analysis is often cited by publications such as the Wall Street Journal, Barron's and the New York Times.
Hickey recently sat down with ETF.com to discuss the upcoming U.S. earnings season and what the current wave of negative revisions to corporate profit forecasts means for stock returns ahead. He shares his views on the U.S. economy, the level of interest rates and future direction of the dollar.
ETF.com: Let's get started with the corporate earnings season, which kicks off officially with Alcoa today [April 8]. Tell us what you expect from it.
Paul Hickey: Just for starters, expectations have come down significantly for the market and for all 10 individual sectors. While everyone focuses on energy, in reality, analysts have been cutting their estimates across the board. Analysts are expecting profits to decline for the first time since the third quarter of 2012. It is the biggest decline since 2009.
The results aren't going to be good. But everyone is well aware of that. What is more important is how the market is going to react when actual earnings announcements start rolling in, given that the bar has been set so low.
We looked back at prior quarters where analysts had been cutting estimates on more companies than they've been raising estimates for leading into earnings season. What we found is that when the number of cuts exceeds positive revisions, the S&P 500 gains an average of about 2.4 percent during earnings season. And it shows positive returns more than 80 percent of the time. Conversely, when you see positive revision exceeding negative revision, the S&P's average return has actually declined 1.2 percent, with positive returns only 40 percent of the time.
There's a clear-cut trend where low expectations on the part of analysts has translated into positive returns for the market. Like I was saying earlier, coming into earnings season, the negative revisions outnumber positive revisions by more than 2-to-1. In the S&P 1500— which comprises the large, mid- and small-cap stocks—there's been about 700 negative revisions in the last month, and 300 stocks have seen positive revisions.
Even if you took energy out, the ratio would still be close to 2-to-1 negative. There have been only three quarters in the last six years where we saw a more negative revision spread. And in each of those three earnings seasons, the S&P 500 gained between 4 percent and 5.5 percent.
These trends also hold true at the individual sector level. Especially from an ETF perspective, there are some sector funds that we find interesting right now, given this trend. One of them is the Industrial Select SPDR (XLI | A-91), which represents the industrial sector. The revisions ratio in that sector has only been this low heading into an earnings season three other times in the last six years. And in each of those periods, the industrial sector was up 5.3 to 9.4 percent in the ensuing six-week period of earnings season.
The industrials are made up of large multinationals, so the results probably aren't going to be great—impacted by the strong dollar and relatively weak economic data. But again: "Tell us something we don't know." Everybody is well aware of this and it's priced into the market.
ETF.com: Are there any other sectors where the sentiment is so negative that chances are they will actually outperform?
Hickey: Consumer staples is another sector where the revisions ratio hasn't been this low since about 2009. Sentiment is very negative, again because of the large multinational companies there. When the bar is set that low, it's easy to surpass it.
ETF.com: Let's take our discussion beyond the immediate horizon and this earnings season. We've had some analysts here on Alpha Think Tank like Ed Yardeni, who think the U.S. is in a secular bull market that will continue for a few more years. On the other hand, we've had others like Axel Merk pointing out that the dollar rising in tandem with the stock market is a sign the bull market is approaching its end and investors should be cautious. What is your view?
Hickey: The fact that the dollar is rising shouldn't be considered a negative fact here. Dollar trends tend to be measured in years rather than months or quarters. The dollar's rally is usually a multiyear process. We think we're probably in the midstage of it. The dollar bottomed in 2009 and it really didn't get going until the second half of last year.
During the '90s, we had a strong dollar and equities did well. During the 2000s, we had a weak dollar, and U.S. equities underperformed. Right now we're in a decade where we're going to see a stronger dollar. But just because both the dollar and stocks are rallying isn't necessarily a red flag, in our view. Historically speaking, when you have a strong dollar, U.S. equities show more strength than during periods when the dollar is weak.
ETF.com: So your view is that this earnings weakness is a temporary blip and the U.S. economic expansion will continue for a while still?
Hickey: Yes, I think so. The market is going to be dependent on the Fed. When the window for the Fed to raise interest rates gets pushed further out, equities do well. When the market starts to anticipate the Fed hiking earlier, we run into trouble. So as we get closer to the period where the Fed lifts off, we're going to see some volatility in the market. But I don't think it's going to set the stage for the end of the bull market or the end of the economic expansion.
ETF.com: Speaking of interest rates, a lot of people are concerned about their exceptionally low level on an absolute basis and that a potential return to the historic average would have a very negative effect on both bonds and stocks. At the same time we've had analysts here, like David Kotok, who expect U.S. interest rates to continue going down because of what's going on in the rest of the world. Give us your thoughts on this.
Hickey: Yes, people have been calling for the increase in rates for years now, and it just doesn't seem to come. Throughout this year, we don't see interest rates, rising much at all, if any. The bond buying from the ECB is going to keep a weight on rates over in Europe. And that in turn will help keep an anchor on rates here.
For most of this year, I don't see interest rates spiking from where they currently are. While I may not necessarily want to be long Treasurys, I definitely wouldn't short them either. As far as the stock market is concerned, where valuation is dependent on earnings and the general level of interest rates, I don't see a sudden rise in rates as becoming a major roadblock for equities.
ETF.com: Thanks for your time.