I am reasonably confident that had we been in a ‘normal’ market environment, the modest revenue ‘misses’ from Amazon (AMZN - Free Report) , Google’s parent Alphabet (GOOGL - Free Report) and a number of other major players would have been shrugged off. After all, it is not every day that the market gets to see companies the size of Amazon and Alphabet to be able to come out with quarterly revenue growth rates of +29.3% and +21.9%, respectively. But these are not ‘normal’ times.

We are going through a phase when the market is grappling with its collective outlook for the duration of the current economic cycle, both here in the U.S. as well as internationally. We need this context to appreciate the market’s ‘disappointment’ with Amazon even though it was able to grow its top-line by +29.3% from the same period last year to $56.6 billion.

Beyond Amazon and Alphabet, Q3 earnings results show that companies have been struggling to beat consensus revenue estimates. With Q3 results from almost 48% of the S&P 500 members already out, as of Friday, October 26th, the proportion of companies beating revenue estimates is the lowest since the fourth quarter of 2016, as you can see in the chart below.

The issue is bigger than companies’ inability to beat consensus revenue estimates; it is more about less than reassuring guidance and outlook for the current and coming quarters. But this weakness on the revenue and guidance fronts feeds into the narrative of skepticism about the longevity or staying power of the current economic cycle. The market is even more disappointed with Amazon and Alphabet as it sees these and other companies like them to have less of the type of cyclical exposure that ‘afflicts’ the likes of Caterpillar (CAT - Free Report) and 3M (MMM - Free Report) and other old-economy companies.

These are all legitimate concerns, but we know that markets tend to overshoot, in both directions. Take a look at the 5-year valuation chart for the S&P 500 index below.

The index is currently trading at 16X forward 12-month earnings estimates, down from 19.1X on November 30th, 2017. But as you can see in the chart above, the index is currently trading at levels last seen on September 30th, 2015. We know that a lot of market friendly and pro corporate earnings developments have taken place since September 30th, 2015. Admittedly, some new risks have emerged as well, including the trade uncertainty, Fed tightening and recession worries.

That said, there can be only one correct interpretation for the above valuation chart – either the market is direct cheap or earnings estimates are too high.

The chart below of actual and projected quarterly earnings growth expectations highlights the next four quarters.

As you can see above, the growth pace is projected to decelerate in a notable way in the coming quarters, with the tax-cut benefits in the base year as the primary reason for this ‘slowdown’.

But as we have seen in commentary from Caterpillar, 3M, Texas Instruments (TXN - Free Report) and others, the combination of rising input costs and moderating international economic growth will likely result in estimates for the coming quarters to get revised lower. We have started seeing some of that already, as you can see in the chart below of how 2018 Q4 earnings growth expectations have evolved since the quarter got underway.

But for the market valuation to make sense, estimates likely need to come down a lot more than what we have seen already. I am skeptical that we will that magnitude of negative revisions in the coming days, which makes me optimistic about the direction of stock prices than the prevailing mood would suggest.  

Q3 Earnings Season Scorecard (as of Friday, October 26th)

We now have Q3 results from 239 S&P 500 members or 47.8% of the index’s total membership that combined account for 56.1% of the index’s total market capitalization. Total earnings for these 239 companies are up +23.2% from the same period last year on +9.2% higher revenues, with 77.8% beating EPS estimates and 60.3% beating revenue estimates.

The proportion of these companies beating both EPS and revenue estimates is 50.6%.

The comparison charts below put results from these 239 index members in a historical context.

As you can see in the charts above, the growth pace is about in-line with what was expected. The one metric in these charts that really stands out is the proportion of positive revenue surprises, as pointed out already.

We have a very busy reporting docket this week, with more than 900 companies reporting Q3 results, including 140 S&P 500 members. There are plenty of big-name companies reporting this week, but the focus will be on Facebook (FB - Free Report) and Apple (AAPL - Free Report) in the wake of the Amazon and Alphabet ‘disappointments’.

Overall Expectations for 2018 Q3

The blended earnings growth expectation for the quarter has been steadily going in recent days as companies come out with better than expected results. Combining the actual results for the 239 companies with estimates for the still-to-come 261 index members, total S&P 500 earnings are expected to be up +22.4% from the same period last year on +7.5% higher revenues.

For the Tech sector, which will be in the spotlight with the Apple and Facebook reports this week, total Q3 earnings are expected to be up +23.6% on +12.1% higher revenues. As is the case with the broader market, earnings growth for the Tech sector is also expected to decelerate in the coming quarters, as the chart below of rolling 4-quarter totals for the sector shows.