More On Q3 Earnings

Not only are the percentage of companies reporting beats and the beat rate better than average, but also the percentage of companies issuing negative guidance is lower than average. 58 companies have issued negative guidance and 28 have issued positive guidance. Just like how companies usually beat estimates, most of the time the guidance is negative. The negative guidance rate of 67% this quarter is below the 75% average. Technology and energy are leading the charge. Energy is expected to have 135% earnings growth which is higher than the 109.6% growth expected at the beginning of the quarter. Technology is expected to have 19.5% earnings growth which destroyed the estimate at the start of the quarter for 8.8%. Keep in mind these updated estimates are blended, meaning they included estimates and reports. The blend is mostly actual results because 91% of S&P 500 companies have reported earnings. 17 firms will report earnings this week.

Beats Barely Gives Investors Any Profits

For those who are claiming the stock market is in a bubble, you can counter that point by showing how stocks are reacting to earnings reports. In a bubble, you’d expect stocks to go up on good and bad earnings. Instead, stocks are getting pummeled when they report bad earnings and they are barley going up when they report good earnings. On average, stocks that missed earnings were down 3.5% when they missed EPS estimates. That’s below the 5 year average which is down 2.4%.

The earnings beats also don’t provide much to investors either. As you can see in the chart below, the average earnings beat pushes stocks up 1.2%. This quarter stocks are only up 0.4% after beats. It’s better than last quarter which had stocks down 0.3% which was remarkable considering the good news coming out. Keep in mind this is the average price change between 2 days before a report and 2 days after the report, so it captures when stocks sometimes bounce back or correct the second day after the report. You can argue that stocks are running up too much prior to quarters. While that might be true, the fact that everything isn’t considered amazing shows the market isn’t euphoric.

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International Sales & Profit Growth Exceed Domestic Growth

The international earnings are once again driving growth. The themes this year continued in Q3 showing us that the only difference between Q3 and the first half of the year’s reports was the hurricane related weakness. The themes will continue into next quarter, but I worry they will end in the second half of next year. That doesn’t matter to today’s stock market as it’s only a blip on the radar screen. For now, investors are focusing on the great reports because 2017 has been one of the best earnings years in this expansion.

It would make sense that this year’s GDP growth would be the fastest of the expansion, but we’ll need to wait a few months for confirmation of that. We still don’t know how fast Q2 growth was exactly. The U.S. economy is being dragged higher by global trade just like how earnings are being helped by international profits. As you can see from the chart below, the companies with over 50% of their sales outside of America had over double the earnings growth of the average S&P 500 firm and sales growth in the double digits. Without firms with prevalent international sales, earnings growth would only be 2.3%. This information goes hand in hand with which sectors are doing the best since technology firms are the ones with a huge international footing.

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Traders Ignore Natural Disasters

The natural disasters are a temporary earnings block which is expected to subside in Q4 as growth is expected to be 10.0%. If the usual trends are followed, estimates will fall in the next few weeks and then be beaten when results come out. Obviously, the determining factor for stocks will be how much they beat and how much the estimates fall. What I’m getting at is that stocks as a whole correctly didn’t fall because this was temporary weakness.

However, what is particularly surprising is that the insurers also have seen their stocks rise after the storms. The chart below shows the S&P supercomposite insurance index. As you can see, the index fell in August and early September before bouncing back to make new highs in October. The natural disasters are labeled. Hurricane Harvey was the biggest problem. It shows in the stocks because they seem to have ignored the Mexican earthquake and hurricane Maria. I’m surprised at the quick gains because of all the losses these firms suffered because of the claims being made from the storms. The bulls believe that the insurance premiums increasing as a result of these storms will help the industry in the long term as long as next year isn’t a repeat of this year.

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Future Expectations

The table below shows the Goldman top down and consensus bottom up adjusted earnings estimates for each sector in 2017 and 2018. As you can see, the energy sector is expected to have a sharp deceleration from triple digit gains to either 16% growth according to Goldman or 35% growth according to the consensus. The only differences between Goldman and the consensus are in technology, energy, and consumer discretionary. I think Goldman’s estimates are more realistic. If Goldman is right, I don’t think stocks will fall; they’ll just increase less. A lot rides on the profitability of the tech sector which isn’t exactly news since it is the biggest sector in the S&P 500 in terms of earnings. The cloud (Amazon & Microsoft), iPhone sales, and the online ad market (Alphabet & Facebook) will once again be the key industries in the tech sector.

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Conclusion

Even though I said stocks aren’t too worried about the second half of 2018 when I expect earnings growth to decelerate, it doesn’t mean you shouldn’t care. It’s best to be ahead of the market. I’d be cautious because of this. That advice is in tune with the fact that stocks have had such a marvelous year in 2017. It doesn’t hurt to sell after such a long streak without a sell-off.