Investors should beware of companies playing down earnings expectations just to beat them on the day, Société Généralé's Albert Edwards has warned.
According to the famously bearish strategist, ‘soothing' headline earnings reports provided by ‘cheating' companies in the US are misleading. Instead, he argued, earnings optimism is falling sharply away and the flash crash may signal "a deeper malaise".
He said: "We have long believed that the US reporting season should in fact be called the US cheating season.
"Companies game the market to ramp earnings down ahead of company announcements, only to beat analysts' estimates by 1¢ on the day."
"Apparently companies believe the feel-good news headlines of an earnings beat will offset the negative impact of downward guidance ahead of the report."
While companies have played this trick in the past, Edwards suggested this time the period of downgrading forecasts is yet to be followed by a clear reporting season bounce.
Edwards' gloomier picture is also clouded by the prospect of deflationary winds may reaching US shores: "We need to be watching this weaker than expected earnings optimism data closely," he said.
A sharp decline in earnings per share optimism is consistent with previous hiatuses in financial markets, he added: "In other words, there may be more to the recent flash-crash than just one weak retail sales datum - a deeper malaise surrounding weak profits may be driving events."
Figures from FactSet, however, suggest a significant proportion of companies are indeed beating estimates: as of last Friday, 75% of the 208 US companies to have reported earnings had beat expectations.
But those beating estimates are being rivalled by a growing number issuing profit warnings, in the UK at least: a report by consultancy EY released this week found that profit warnings at UK firms reached their highest level since 2008 in Q3.
Black line: Upgrades/Downgrades Red: Number of earnings news announcements. Source: Factset
Net balance of company earnings per share upgrades as % of total estimate changes. Source: Datastream
