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Spotlight on Q2 Earnings

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Tuesday, July 8, 2014

Stocks lost ground on Monday and appear on track to start today’s session on the weak side as well. The 2014 Q2 earnings season will likely be the next catalyst for the market, determining whether stocks continue their recent uptrend or start losing altitude.

Alcoa’s (AA - Free Report) earnings announcement after the close today will put the spotlight squarely on the Q2 earnings season. The aluminum producer’s earnings release generally gets credited as the kick-off for each quarterly reporting cycle. From our perspective, however, the earnings season gets underway much before Alcoa’s release.

Same is the case for Q2: Zacks and most other data compilers count all companies with fiscal quarters ending in May that have reported results already as part of the Q2 bucket.

By this measure, we have results from 22 S&P 500 members already in the bag, which includes such industry leaders as FedEx (FDX - Free Report) , Nike (NKE - Free Report) , Oracle (ORCL - Free Report) and others already out. The growth rates, surprises and guidance thus far from this admittedly small sample of 22 companies are broadly comparable to what we have seen from the same group of companies in recent quarters. In other words, it’s too early to draw even preliminary conclusions from the results that we have seen thus far.

Including Alcoa, we have only 5 companies reporting results this week, with the cycle ramping up next week with more than 60 S&P 500 members reporting results, including all the major banks & brokers and a number of technology companies.

The growth picture is expected to modestly improve from Q1’s anemic pace, but it’s not much to write home about. Total earnings for the S&P 500 are expected to up +3.1%, on +1% higher revenues and just a tad-bit higher net margins. In-line with the trend that has been in place for quite some time, estimates for Q2 came down as the quarter unfolded, with the current +3.1% expected growth rate down from +5.5% at the start of the quarter.

The negative revisions trend was widespread across all sectors, but was particularly pronounced for Basic Materials, Autos, Consumer Discretionary  and Finance.  Estimates for the Medical and Aerospace sectors modestly went up. The magnitude of negative revisions in Q2, however, was relatively on the low side compared to other recent quarters, likely indicative of the analyst community’s improving growth outlook.

A lot will be riding on how the consensus growth outlook for the second half of the year and beyond evolves. Expectations remain high, with consensus estimates for Q3 and beyond reflecting a material ramp up in the growth trajectory. The +3.1% earnings growth rate in Q2 is followed by +5.6% growth in Q3 and +8.9% in 2014 Q4, with double-digit growth rates expected in the first two quarters of 2015.

For these expectations to hold, we need to see an improvement on the corporate guidance front. The U.S. economy has bounced back in Q2, as last week’s strong payrolls report confirms. But it will be interesting if management teams see Q2’s improving growth trends continuing into the following quarters.

Improvement on the guidance front will confirm the market’s recent gains and potentially give the ammunition to continue its uptrend. But the reverse is true as well. It will be difficult for stocks to hold to their recent gains in the face of a sub-par earnings picture.

Sheraz Mian
Director of Research

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