And they’re off! Q1 earnings race begins with earnings, guidance off the pace
Earnings season—in many ways a cross between weather forecasting and horse racing—is once again upon us as investors seek the purse.
Last quarter, we outlined key earnings drivers, including a strong but decelerating economy, troublesome trade wars, and fluctuating energy prices. Those factors remain and could still affect first-quarter corporate earnings. But several other potential hurdles have been cleared for the time being, and the markets appear to be assuming a more risk-on tenor, with major indexes either hitting or closing in on record highs.
Curious how your portfolio will weather the latest earnings season? A few furlongs into this contest, let’s size up where earnings currently stand.
Plenty of positive earnings surprises …
Although it’s still early, the beats and misses appear to be playing out much like last quarter. With 15% of S&P 500® constituent firms reporting as of last Friday, 78% have posted upside earnings surprises, which is above the five-year average, while 53% have reported positive revenue surprises, which is below the five-year average. At around this time last quarter, those percentages were 76% and 56%.1
Higher-than-expected profitability in a challenging growth environment could reflect effective cost controls and increased operating leverage. This makes sense given that among the earliest companies to report have been large financial services firms, some of which reduced headcount in recent years. Three of the bigger names in the financials sector—Goldman Sachs, Bank of America, and Citigroup—all posted impressive first-quarter earnings against declining revenue.
Data source: FactSet Research Systems
For the record, the sector with the highest differential between estimated and actual earnings has been communication services. Netflix was a major factor here when it posted first-quarter earnings per share of $0.76, well above the $0.58 per share predicted by analysts.2
… even though earnings are trending downward
But there’s a difference between earnings surprises and actual numbers. Although a high percentage of companies are surprising analysts with their bottom lines, first-quarter earnings reported by S&P 500 constituents are down by an average of roughly 4% from last year, according to FactSet.1
Remember, we are 10 years into an extraordinarily long bull market. Within this context, analyzing performance is somewhat like watching a pro hockey team made up of aging veterans: Some players are outperforming others, but on balance the team is scoring fewer goals than it did a year ago. However, the drop-off isn’t nearly as bad as the beat writers anticipated. Thus, the positive surprises.
According to FactSet, if current trends hold, this will mark the first time the S&P 500 index has seen a year-over-year decline in quarterly earnings since 2016.1 If you’ll recall, that’s when many market observers were complaining of a slow-growth environment.
Earnings guidance is also off the pace
Stock valuations reflect future growth prospects, and earnings guidance can affect stock prices every bit as much as backward-looking earnings.
On this front, there’s not much to cheer. Granted, the sample size is small—only 10 S&P 500 companies have issued earnings guidance for the second quarter. Of those 10, nine have lowered their second-quarter estimates. In addition, sell-side analysts are predicting a 0.5% decline in second-quarter earnings for S&P 500 companies on modest earnings growth. The upshot? Analysts are also predicting that corporate earnings will rebound nicely in the second half of the year.1
Data source: FactSet Research Systems
Several roadblocks have been cleared
The earnings picture is mixed to be sure, but investors have reason for optimism given the recent removal of three key roadblocks.
• Monetary policy: The Federal Reserve declined to raise interest rates at its last policymaking meeting and has struck a decidedly dovish tone so far in 2019. Fed funds futures predict a more than 80% chance of no interest rate hikes through June, which should bode well for consumer spending and lending activity.
• China: Fears of a Chinese slowdown have recently factored into diminished earnings expectations, particularly for large multinationals. But Chinese gross domestic product bounced back 6.4% in the first quarter, buoyed by stimulative government policies.3 Trade war or not, that is good news for the global economy.
• Brexit: Britain’s complicated divorce from the European Union has hung over the eurozone since the fateful Brexit vote in June 2016. With British Prime Minister Theresa May securing a six-month reprieve, the common market remains intact, which should prevent disruptions to global trade. But the logistics of cross-border commerce between Northern Ireland and the Republic of Ireland in a post-Brexit world remains a major sticking point. If an agreement couldn't be reached after nearly three years, there’s little reason to expect one in six months.
With the lion’s share of companies still to report, we’re nowhere near the final stretch in this latest earnings race. While first-quarter earnings appear to be off last year’s pace, central banks around the world are exercising caution, and many forecasters are predicting a pick-up in global growth rates in the second half.
Hold onto your horses. It could get interesting.
1. FactSet, “Earnings Insight,” April 18, 2019, https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_041819.pdf
2. CNBC, “Netflix stock slightly negative after post-earnings rally,” April 17, 2019, https://www.cnbc.com/2019/04/17/netflix-rallies-after-an-initial-dip-on-q1-2019.html
3. MarketWatch, “China’s economy grew 6.4% in Q1, beating expectations,” April 16, 2019, https://www.marketwatch.com/story/chinas-economy-grew-64-in-q1-beating-expectations-2019-04-16