April 9, 2018

Q1 2018 Earnings Season Starts This Week

The Financial Times – Can earnings season lift the US stock market?
S&P 500 down just 2.6%, but bigger swings have become far more common in 2018
Starting this week, corporate profits, revenues, and management outlooks will intrude on a stock market narrative that in recent weeks has been dominated by trade tensions and regulation of Big Tech. On Friday JPMorgan Chase will be among the first big US corporations to report first-quarter earnings, and for the whole of the S&P 500 expectations are high. Companies in the benchmark index are forecast to report that profits rose 17.1 percent from a year ago, according to FactSet. “Stronger earnings are a necessary underpinning for this market to get out of this volatile period,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Earnings season is always important but I think this one carries even more weight.”

Summary

Typically, earnings estimates are guided lower as the quarter drags on. Over the past few months, however, Q1 estimates rose to an eye-popping 17% year-over-year growth rate. Economic optimism and corporate tax cuts have set the bar higher than any quarter this late in an economic cycle.

Comment

As the story above points out, earnings season starts this week. With it come big expectations.

The next chart shows the estimates for Q1 2018 operating earnings for the S&P 500 (blue), the S&P 500 ex-financials (green) and the S&P 500 ex-energy (red). This late in an economic cycle, growth of this magnitude has never been seen before.

The next chart shows S&P 500 earnings expectations over the last 13 quarters. These series start with 500 estimates and are replaced with actual results as companies report.

We offer three main takeaways:

Earnings estimates usually start high and are lowered until reporting season begins (gray vertical lines). Once companies report beat estimates, the growth rate shoots higher.
Q1 estimates broke this pattern due to expectations of booming economic growth and tax cuts.
The growth rate of 16% for Q4 2017 and 17% for Q1 2018 are well above anything seen in recent quarters. In fact, based on charts from Ed Yardeni, we cannot find any example of earnings growth popping like this so late in the economic cycle. Big growth rates like this usually only occur after a recession when earnings are coming off year-over-year declines.

Full-year 2018 S&P 500 operating earnings (blue) are expected to be up nearly 21%. Again, for year 8 of a recovery, this is unprecedented.

To further illustrate how different earnings expectations are for 2018, see the next chart.

We have covered the gamed nature of earnings estimates many times in the past. In a nutshell, analysts often offer more optimistic earnings estimates early on only to be guided lower by company guidance as the actual quarterly release draws closer. This sets up a low hurdle for most companies to beat.

As the chart below shows, the average beat rate in the post-crisis period is 69% (black line). If a similar percentage of companies beat estimates this quarter, a 20% growth rate in earnings is possible. Since analysts’ estimates were never really lowered for Q1, however, we will have to wait to see if such a high beat rate still occurs.