Pessimistic expectations bring U.S. economic “surprise” back to positive territory

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While globally financial markets are focused on the turmoil in Europe, particularly recent news out of Greece and Italy, U.S. investors continue to keep a watchful eye on what is happening with the domestic economy and companies. The concept of “surprise,” or how well an indicator’s actual released value compares to the advance estimates for that indicator, plays an important role in equity markets. What are economic and company earnings estimates telling us right now about the path of the U.S. economy and the performance of the stock market?

The Citigroup Economic Surprise Index is an aggregate measure of how economic data press releases compare to market expectations. The daily U.S. index slipped to new lows over the summer, hitting a trough of -117.2 on June 3; these were the lowest readings since late 2008/early 2009 when the worst of the financial crisis was hitting markets. However, in just the past few weeks, the index has turned the corner into positive territory. A general trend toward beating estimates may simply be a reflection of lower expectations among economic analysts. Over the summer, the idea of a double dip recession seemed to gain more traction as more and more economic data releases failed to meet expectations, and estimates were likely adjusted downward accordingly.

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We are certainly seeing this trend with company earnings estimates. Results of the most recent earnings season (Q3 2011) are mostly in, and 72% of companies in the S&P 500 reported earnings above the mean estimate. This ratio is consistent with the 74% average recorded over the past four quarters, according to FactSet Estimates. However, what this statistic doesn’t tell us is that many of these companies are beating estimates that were lowered during the course of the quarter. In fact, EPS estimates for 2012 have been cut sharply over the last three months for the S&P 500 as a whole.

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Nevertheless, equity market performance is positively correlated with the surprise factor for both economic and company estimates. U.S. analysts remain optimistic that continued positive news here at home will translate into economic recovery and a strong stock market, although events overseas still remain the wildcard driving daily fluctuations.