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Will Q3 Earnings Help Drive the Market Higher?

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The big banks gave us a so-so start to the Q3 earnings season. But hopes remain high that the favorable momentum that has been on display over the last few quarters will get reconfirmed in this earnings season as well.

The bank results weren’t bad, but they weren’t great either. Total earnings for the major banks, which combined account for almost one-third of the sector’s market cap in the S&P 500 index, are up +7.2% from the same period last year on +1.9% higher revenues, with 85.7% beating EPS estimates and 42.9% beating revenue estimates. This is weaker growth than we have seen from the same major banks in other recent periods, as the chart below shows.

Looking at the Q3 earnings season as a whole, we now have results from 33 S&P 500 index members that combined account for 10.6% of the index’s total market capitalization. Total earnings for these 33 index members are up +13.1%  from the same period last year on +6.4% higher revenues, with 81.8% beating EPS estimates and 75.8% beating revenue estimates. As you can see in the comparison chart below, the growth pace is about in-line with what we had seen from the same group in the preceding quarter. Please keep in mind that the preceding quarter represented an all-around strength on the earnings front.

For Q3 as a whole, total earnings for the S&P 500 index are expected to be up +2.3% from the same period last year on +5% higher revenues. Actual Q3 earnings growth will be better than this level, with the final growth level for the quarter likely three or four percentage higher than this level. But even then the Q3 earnings growth will represent a notable deceleration from the growth pace of the preceding two quarters.

The growth deceleration in Q3 is not worrisome as the growth pace is expected to ramp back up from the current quarter onwards, as the chart below shows.

A big part of the stock market impact of the Q3 earnings season relates to what happens to expectations for the current and coming quarters. The earnings picture has been favorable for the last few quarters and this has been a contributing factor to the market’s strong gains this year. Continuation of this favorable trend in this earnings season will help sustain the market’s gains, particularly for the large-cap stocks.

For the small-cap stocks, this earnings season is expected to usher in a notable turning point, with earnings for the small-cap S&P 600 index on track to reach double-digit levels in Q3. Please note that earnings growth for the S&P 600 index has been in negative territory in three of the last four quarters. In fact, the small cap earnings picture has been weak for a while, with growth in six of the last 10 quarters in negative territory.

Importantly, the small cap growth resumption in Q3 is not an isolated development, with small-cap earnings growth expected to accelerate further in the coming quarters. More than the large-cap results this earnings season, results from the small-cap companies likely will have a bigger stock-market bearing. Strong small-cap Q3 results will not only add to confidence in current optimistic expectations for the coming periods, but will likely add to the space’s recent momentum.  

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