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Earnings growth is expected to be in negative territory in the Q3 earnings season, which will follow 5 back-to-back quarters of earnings declines for the S&P 500 index. But many in the market don’t see the earnings picture in those grim colors. In fact, many see this earnings season as an inflection point, with earnings declines coming to an end and steady growth resuming from Q4 onwards. Driving this view are three key points.
First, the magnitude of negative revisions that Q3 estimates suffered were lower compared to what we had seen in the preceding quarters. Estimates for Q3 came down as companies reported Q2 results and guided lower, with expectations of earnings growth for the S&P 500 index dropping from an essentially flat reading at the beginning of July to the current -2.9%. This is a lower drop than we became used to seeing in the comparable periods in the preceding quarters.
Second, the -2.9% decline in Q3 earnings on +1% higher revenues will be the lowest decline rate expected at the start of the season. At the comparable stage in the Q2 earnings season, earnings growth for the S&P 500 index was expected to be -6.2%, which actually turned out to be -2.8%. We had similarly bigger decline rates expected at the start of earnings season in Q1 and the quarters prior to that, with actual earnings growth rates coming in better than pre-season expectations by about +2% to +3%. If Q3 results follow this trend, the finally growth tally will most likely be close to a flat finish.
Third, the Energy sector still remains a big drag on the aggregate growth picture, with total earnings for the sector expected to be down -66.6% from the same period last year. Excluding the Energy sector, total earnings for the S&P 500 would be modestly in positive territory, up +0.3%. The Energy sector still has plenty of challenges, but the tyranny of tough comparisons is starting to fade. It is a smaller burden in Q3 than was the case in either of the preceding two quarters and comparisons are expected to turn positive in the following earnings season.
Standout Sectors this Earnings season
Earnings growth is expected to be negative for half of the 16 Zacks sectors, led by Energy (- 66.6%), Transportation (- 21.8%), and Autos (- 18%). The Transportation decline is primarily concentrated in the legacy air carriers, particularly American Airlines (AAL - Free Report) and United Continental (UAL - Free Report) that are experiencing higher costs following recent labor contract awards. The Auto sector’s growth issue is primarily due to Ford (F - Free Report) , which guided lower the last earnings season.
Growth is expected to be negative for the Technology sector as well, with total earnings for the sector expected to be down -1.9% from the same period last year on -1% lower revenues. The Tech growth challenge is primarily concentrated in Apple (AAPL - Free Report) whose September-quarter earnings are expected to be down -20.7% on -9.6% lower revenues. Excluding Apple, the sector’s Q3 earnings would be up +2.9% on +0.5% higher revenues.
On the positive side of the ledger, we have Construction (+7% earnings growth in Q3), Business Services (+6.7%), Retail (+4.5%), Utilities (+4.6%) and Finance (+3.7%).
Estimates Beyond Q3
The chart below shows Q3 growth expectations contrasted with what was actually achieved in the preceding four quarters and estimates for the following three periods. Full-year 2016 earnings growth expectations are now negative, similar to what we saw last year.
Beyond the current period (September quarter), meaningful growth is expected to resume from Q4, which is then expected to continue into 2017.
Easier comparisons for the Energy sector arrive in Q4, when the sector’s earnings growth turns positive. But the expected growth in Q4 and beyond isn’t solely a function of easy comparisons for the Energy sector – the expectation is for positive momentum from a broad cross section of sectors. Those expectations will most likely need to come down. But it will be interesting to see to what extent they will have to come down.
Note: Sheraz Mian manages the Zacks equity research department. He is an acknowledged earnings expert whose commentaries and analyses appear on Zacks.com and in the print and electronic media. His weekly earnings related articles include Earnings Trends and Earnings Preview. He manages the Zacks Top 10 and Focus List portfolios and writes the Weekly Market Analysis article for Zacks Premium subscribers.
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