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Should We Worry About the Downtrend in Earnings Estimates?

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We continue to be optimistic about the overall corporate earnings backdrop and the flow of earnings releases in the ongoing Q2 earnings season provides further confirmation of that view.

Overall growth remains strong, with all around positive surprises and plenty of momentum on the revenues side.  The one area of concern is the revisions trend for the current period (2018 Q3), which is at odds with what we had been seeing in the comparable periods in the preceding three reporting cycles. You can see this in the chart below that shows how 2018 Q3 estimates for the S&P 500 index have come down over the last four weeks.

We don’t want to come across as overly alarmist on the revisions front, but it is nevertheless a negative development in an otherwise very strong Q2 reporting cycle. It may be premature to call this emerging revisions trend as negating all the other positives, but it nevertheless warrants close monitoring.

We have a very busy reporting docket this week, with 49 S&P 500 members on deck to come out with results that will take the total number of index members that have reported already to 430 or 86% of the total membership. The earnings season has actually come to an end for the Autos and Conglomerates sectors and most of the other sectors in the index are also mostly done reporting Q2 results, with the Retail and Consumer Discretionary sectors as the only ones that substantial results still to come. This week’s reporting docket has plenty of operators from the Consumer Discretionary and Retail sectors like Disney (DIS - Free Report) , Michael Kors , Macy’s (M - Free Report) and others.

Q2 Earnings Season Scorecard (as of August 2nd, 2018)

We now have Q2 results from 381 S&P 500 members that combined account for 82.7% of the index’s total market capitalization, with total earnings for these 381 companies up +25% from the same period last year on +10.4% higher revenues, with 80.1% of the companies beating EPS estimates, and 73.8% surpassing revenue estimates.

The comparison charts below put results from these 381 index members in a historical context.

As you can see, the earnings and revenue growth pace is above the other comparable periods in the left-hand chart. The 80.1% proportion of these companies beating EP estimates is above what we had seen from the same group of companies in other periods while the proportion of revenue beats is below the preceding period but materially above the historical level.

Overall Expectations for 2018 Q2

Looking at Q2 as a whole, combining the actual results from the 381 index members with estimates from the still-to-come 119 companies, total earnings are expected to be up +23.9% from the same period last year on +9.3% higher revenues, with double-digit earnings growth for 14 of the 16 Zacks sectors. This would follow +24.6% earnings growth in 2018 Q1 on +8.6%, the highest growth in almost 7 years.

The table below shows the summary picture for Q2, contrasted with what was actually achieved in Q1.

The Earnings Growth Peak

The chart below compares current Q2 earnings growth expectations with what was actually achieved in the preceding 5 quarters and what is expected in the following 4 quarters.

When market commentators talk about earnings growth peak, it is the growth comparison in this chart they are referring to. Looking at this chart, it is obvious that growth has peaked already, with the pace decelerating going forward. That said, the Q2 growth rate has steadily risen as companies have come out with better than expected results and we can reasonably expect that by the time this earnings season comes to an end, the growth pace will most likely have exceeded the Q1 level.

The chart below shows the growth pace on trailing 4-quarter basis, which tends to smooth out the quarter-to-quarter jumps.

The two charts above provide different answers to the ‘peak earnings’ question. The first chart shows that the growth rate likely peaked in 2018 Q1, while second chart shows the expected to ‘peak’ to arrive in the last quarter of the year.

We should keep in mind that this earnings cycle got underway back in 2009 when the U.S. economy got out of its last recession. By this time, earnings growth should have come down to the historical ‘normalized’ pace in the mid-single digits level. The reason we have these impressive growth numbers is thanks mostly to the effect of the tax cuts, which will start wearing off towards the end of 2019.

In other words, earnings likely haven’t peaked yet. But with this cycle so long in tooth, we are steadily moving towards that stage.

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