Bleeding Edge Of Data

I used to use FactSet’s numbers in these articles to review S&P 500 earnings, but I recently switched to using data from The Earnings Scout because The Earnings Scout does a better job of showing the rate of change in future estimates. Investors are always on the bleeding edge of data. The more recent the information, the more valuable it is. The most valuable metrics to investors are the rate of change of future expectations. When FactSet calculates the earnings data, it usually shows the information for the whole quarter without clearly breaking down the differences in the data week by week. Being on the bleeding edge of data means you need to know the rate of change of Q3 and Q4 earnings estimates each week.

You can’t look at the overall data from Q2 because there’s no breakdown of the recent changes. That’s not to say the FactSet data has no merit; it’s just not going to give you an edge to make money in the intermediate term. It depends on if you want to make money on the earnings information or if you want to judge the overall trend of the data to get an idea of where the economy is heading while using other metrics to give you an edge. Do you want earnings data to be the metric which makes you money or complements your investing process? The Earnings Scout data is the former and FactSet is the latter in its free reports. This isn’t a plug for a particular product; it’s an explanation of how to review the earnings data.

Improvements In The Earnings

The table below shows the changes in the earnings growth rate estimates for each quarter. You can see the initial bump in estimates because of the tax cut. Then there was another bump in estimates after the Q1 earnings reports came out. The true measurement of results is how they affect future estimates. If earnings beat but don’t help future estimates, it means one time events dominated results or that the trend is turning. The good news from this table is that the past two weeks of data, from June 1st to June 15th, saw Q3 estimates go up from 23.39% growth to 23.73% growth and Q4 estimates go up from 15.18% growth to 15.37% growth.

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Revisions Don’t Look Great

The table above is a great summary because it shows the changes to Q3 and Q4 estimates instead of just Q2. However, it’s not complete. We need to know the rate of change of the improvements to estimates. One way to understand the bleeding edge of data is to review the latest changes in earnings revisions. FactSet states that 56% of firms in the S&P 500 issued negative earnings guidance for Q2 as 61 firms issued negative guidance and 47 issued positive guidance. That is good news because the 5 year average is 72%. However, that’s not a compete measurement of the data.

The chart below is the best way to understand the recent earnings data. As you can see, the chart shows the S&P 500 compared with earnings revisions. The green line measures positive revisions and the orange line measures negative revisions. The recent trend in the past few weeks doesn’t look good. This chart did a great job of telling you to sell stocks in January and buy them in February and March. Now it is flashing a sell signal again.

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Neutral Position On Stocks

There’s always news events in the headlines trying to explain why stocks moved in a certain way each day. The revisions to earnings are very important even though they get little coverage. That’s not to say each event in the news shouldn’t affect stocks. It’s up to investors to parse each event to determine if it matters and how much it matters. Most stories get ignored after 24 hours. The improvement on the geopolitical front and the increase in trade tensions probably cancel each other out, but every day has new information to review.

One other point when forecasting the next few weeks of equity performance is that once again there will be a blackout period for stock buybacks. That could make Q2 earnings season, which starts in 3.5 weeks, volatile like last quarter. The blackout period starts 5 weeks before earnings come out and 48 hours after they are announced. The financials, which report earnings in mid-July, are already in their blackout period. Apple, which has a major buyback, reports August 7th, so it will be entering its blackout period in about 2 weeks.

The market’s performance in the next 3.5 weeks and the earnings revisions will determine my positioning heading into the quarter. If the S&P 500 hits a new record high and the revisions look the same, we will need amazing results just to keep the market sanguine. Any hiccup could easily cause a 5% correction.

Earnings Scorecard: The Worst Estimate Changes

The big misnomer when it comes to earnings is that results don’t matter because firms that beat estimates don’t always go up. An earnings beat isn’t much of an accomplishment since most firms beat. Sometimes bad reports beat estimates because the bar was lowered so much. Guidance and analyst changes are everything.

46% of S&P 500 firms had their Q2 EPS estimates cut after Q1. Those firms saw their stocks gain 2.2% during this earnings season and fall 0.3% year to date. As you can see, firms’ future cash flows matter. The table below is a list of the 40 firms with the worst Q2 estimate changes in Q1 earnings season. As you can see, 25 out of 40 firms are down year to date. That’s 62.5% of firms with negative performance while the S&P 500 is up. That shows the fundamentals do matter, just as they always do. It’s not just about the long term; fundamentals always matter.  

Conclusion

I could see stocks rallying in the next few weeks now that the Fed meeting, the ECB meeting, and the Trump-Kim summit are all over. The technicals also look strong. However, the earnings revisions are starting to look weak and the blackout period for buybacks will be expanding each day. Therefore, I have moved towards being neutral on stocks in the next few months.