Earnings Estimates For Q3 Drop Further
This week will be the biggest earnings week of the year as 190 firms are reporting, including Facebook, Alphabet, and Amazon. Those three reports will shape the performance of the market for the next few months. If 2 or 3 miss estimates, the rally could be halted, especially in the Nasdaq which has had a great year. Apple reports on August 1st which is next week. That won’t be a critical report as everyone is shifting their attention to the soon to be released new iPhone. In this article, we’ll delve into the latest earnings information that’s available and the future estimates.
According to the S&P Dow Jones numbers, the percentage of firms which have beat earnings estimates has dropped to 72.92% after 19.01% have reported earnings. That’s 4.91% higher than the average beat rate going back to Q2 2013. FactSet posted the chart above in its summary of earnings thus far. It shows that 77% of firms beat sales estimates which is 24% higher than the 5-year average. However, this beat rate hasn’t led to much change in the aggregate numbers as the FactSet sales growth rate improved one tenth of one percent to 5.0%. FactSet blames the lack of a large increase on the weakness from utilities and energy companies.
I went over to the S&P Dow Jones report to get the details on these sectors. It says 72.6% of firms have beat sales estimates. It says only 2 energy companies reported earnings by July 21st and no utility companies had reported yet. The difference between the two reports must be because of the time of day they coordinated the data. S&P Dow Jones says the numbers were as of the morning and FactSet doesn’t say the time of day. Not only do the S&P Dow Jones numbers not corroborate with the FactSet assertion that energy and utilities brought down results, but also FactSet’s own chart shows that energy had the best sales surprise rate. We’ll likely find out the true story of this earnings period when this week’s results are included. Keep in mind, that if energy is beating estimates, that’s only because the bar has been lowered substantially as we will look at next.
I’m assuming that most energy and utilities companies still hadn’t reported earnings by the time FactSet coordinated its data. This could mean that the reported results will face more pressure. The results in the S&P Dow Jones report will definitely be negatively impacted by earnings from energy since it only includes two reports. This could mean the blended estimate of $104.84 in as reported trailing twelve-month earnings might not be hit. The 10.39% margins might fall as well. As you can see from the chart below, with the decline in oil prices, the expected growth in energy sector earnings in Q2 has fallen dramatically. The longer prices stay below $50, the more earnings will fall because the hedges made when oil was higher will expire. We must focus on energy until Q4 2017. After that, the year over year growth numbers won’t be sharp because Q1 2017 was the start of decent results.
To give you a better picture of the expectations energy firms are up against, the chart below shows the implied expected oil prices from analysts for each of the next 4 quarters. With oil at a $46 handle now and spending the entire month of July below $49.75, there will need to be a sharp rally in prices for Q3 earnings estimates to be met. In other words, in the next few weeks analysts will be lowering their estimates for energy which will put downward pressure on aggregate S&P 500 Q3 earnings.
One of the themes I have been discussing for the past few months is that there will be a drop-off in year over year earnings growth in Q3 after Q1 and Q2 are/were excellent. We’re already seeing signs of that as the current estimates are for only 6.4% year over year growth in Q3. The chart below shows the estimates sinking sharply in the past few weeks. As was mentioned earlier, the energy estimates falling may cause Q3 estimates to fall further in the next few weeks. Ironically, a new trailing 12-month record in as reported earnings will be set in Q3. It’s ironic because this new record will be made with a relatively poor quarter. On the bright side, if the big tech names raise their Q3 guidance, it could put pressure to the upside on estimates. Q3 likely won’t include new iPhone sales, so we’ll have to wait until Q4 for that.
The chart below breaks down the equity market returns by region. The blue bar represents changes in earnings and the red bar represents changes in multiples. Emerging markets have had a great year after previously lagging. Returns have been driven almost exclusively by earnings growth as multiples haven’t budged much. The most disconcerting part of this chart is that the USA has had the largest multiple expansion this year. This trend cannot go on as investors will begin to seek value in the rest of the world. A decline in America’s multiple could lead to a decline in stock prices because earnings growth is decelerating. I am very bearish on the S&P 500’s 2018 earnings as I don’t think the 11.5% growth rate expected according to FactSet will be hit. For this year, I’m sticking with my 5%-7% growth expectation. The 9.3% FactSet growth estimate is inching closer to the range I set when it was much higher.
Conclusion
The rest of the summer will likely see great stock performance if the tech firms do well this week and next week. I am growing increasingly weary of how the stock market will do this fall as it will be hit with decelerating margin growth, a debt ceiling crisis, the Fed unwinding its balance sheet, and the announcement that the ECB is tapering bond purchases further in 2018. Therefore, I expect at least a 5% correction sometime between September and December.
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