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Earnings Trends

The market is full time on Fed watch at present, trying to handicap the future of the QE program. This mood is likely to continue through the summer months, though the start of the 2013 Q2 earnings season in a few days could potentially spotlight another source of vulnerability of the market. Expectations for earnings growth have been coming down as the quarter has progressed and currently remain fairly low.


   
The growth picture is even more underwhelming when Finance is excluded from the aggregate growth tally. Given these low expectations, it wouldn’t take much for companies to beat them. But positive earnings surprises may not mean much anymore, since roughly two-thirds of them beat earnings expectations anyway. We have seen that play out with the handful of results from the likes of Oracle (ORCL - Analyst Report), FedEx (FDX - Analyst Report), Adobe (ADBE - Analyst Report) and others already. More than earnings surprises, we will be looking for top-line surprises in Q2, particularly after the unusually weak revenue results in Q1.

Guidance is always important, but it has assumed even more significance this time around given the elevated expectations for the second half of the year. Earnings growth was barely above +1% in the first half of 2013, but it is expected to jump to +9.7% in the back half of the year. Importantly, the growth expectations for the second half of the year are not due to easy comparisons – the level of total earnings in the 2013 Q3 and Q4 each represent new all-time high records.

My sense is that estimates need to come down in a big way. The market hasn’t cared much in the recent past about negative revisions as aggregate earnings estimates have been coming down for over a year now. But if we are entering a post-QE world, as I believe we are, then it would be difficult to overlook negative earnings estimate revisions.

Key Points

  • Expectations remain low, with total earnings for the S&P companies expected to be down -0.3% from the same period last year, reflecting -0.5% lower revenues and flat margins. This follows +2.4% earnings growth in Q1 on +0.5% revenue growth.
  • Estimates for Q2 have come down materially since the quarter got underway, with the current -0.3% decline down from +3.9% growth in total earnings in early April.
  • Finance is the only major sector with a strong growth profile, with total earnings for the sector expected to be up +19.6% in Q2. This follows +7.7% earnings growth in Q1 and many quarters of double-digit gains for the sector.
  • Finance reclaims its leadership role in the S&P 500, contributing more earnings to the index’s total than Technology this year for the first time since the 2008 crisis. The sector is expected to account for 19.3% of total S&P 500 earnings in 2013 compared to Technology’s 17.8%.   
  • Technology earnings were weak in Q1 and they are even weaker this time around, with total earnings for the sector expected to decline -11.8% in Q2 after declining -4.4% in Q1. Weakness in hardware and semi-conductor industries more than offset the modest growth in software earnings.
  • Estimates for the second half of the year still reflect strong growth, with total earnings in the second half of the year expected to increase by +9.7% after the +1.1% increase in the first half. Total earnings are expected to be up 6% in 2013 and +11.6% in 2014.
  • While there is not much growth, the overall level of total earnings is quite high. Total earnings were an all-time record at $253 billion in Q1 and are expected to total $246.8 billion in Q2. For the full year, earnings are expected total $1.03 trillion in 2013 and $1.15 trillion in 2014.   
  • Net margins are expected to be essentially flat in Q2, but start expanding from the third quarter onwards. For the full year 2013, net margins are expected to top the 2006 peak and expand even more in 2014.
  • The bottom-up ‘EPS’ for the S&P 500 for 2013 and 2014 currently stands at $109.18 and $121.72, respectively. The top-down ‘EPS’ estimates for 2013 and 2014 currently stand at $107.83 and $114.80. It seems that Wall Street strategists are a bit less enthusiastic about the earnings picture than the analysts.
Q2 Earnings Expectations Remain Low

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