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Ahead of Wall Street

Friday, April 24, 2015

Stocks appear on track to start today’s session on a positive note and continue the favorable momentum from the last couple of sessions that pushed the Nasdaq into record territory, with the other indexes not that far behind either. Since we are in the thick of the Q1 earnings season, one would assume that the market is applauding earnings reports. But I strongly feel that earnings aren’t the catalyst that’s been pushing stocks higher lately – in fact, it’s anything but earnings.
 
Investors seem thrilled with the Amazon (AMZN - Analyst Report) , Google (GOOGL - Analyst Report) and Microsoft (MSFT - Analyst Report) results even though most of them did not look worth applauding. I find it hard to get excited about the Google report, though the Microsoft report did have elements indicating that the new management team was doing a better job repositioning the company for the times ahead.

In defense of the market’s positive reaction to these otherwise mixed reports, one could argue that expectations had been so depressed that investors end up cheering when the reality turns out to be simply “less bad.” We saw this behavior in play earlier in the reporting cycle with the market’s positive reception to otherwise mediocre reports from Intel (INTC - Analyst Report) and IBM (IBM - Analyst Report) .

That said, the Amazon report did show genuine improvement, particularly that we now know the extent of their cloud business. The company didn’t make any money in the quarter, but you don’t buy Amazon shares because of their profitability – you do it for consistent growth.

Amazon beat on both the top- and bottom-lines. But more importantly, the details emerging from the quarterly release give us a good sense of how big its cloud business actually is. This business provides web services for a lot of mostly start-ups, but also established players like Netflix (NFLX - Analyst Report) . Revenue in the company’s cloud offering, called Amazon Web Services, was up an impressive +49% to $1.57 billion, and it had attractive profit margins to boot. While the company didn’t give all the details about its cloud division, it nevertheless confirms that Amazon has a leg up on other cloud operators like Google, IBM and Microsoft.

Regular readers know that we have been unimpressed with the overall earnings picture emerging from the Q1 reporting cycle at this stage, with the top-line weakness particularly unsettling given the unusually sharp revisions to estimates ahead of this earnings season. The Tech sector’s performance is no different, notwithstanding the positive momentum in the stock market.

Total earnings for the 59.1% of the Tech sector’s market cap in the S&P 500 that have reported results are down -2.7% from the same period last year on +1.7% higher revenues, with only 46.4% of the companies beating earnings estimates and 50% of the companies beating revenue estimates.

Any way you look at it, this is weaker performance than we have seen from the same group of Tech companies in other recent reporting cycles. Stocks aren’t up because of earnings — they are up despite what’s happening on the earnings side.

The updated Q1 scorecard as of this morning now shows that we have crossed the halfway point for the S&P 500 index, not in terms of the total number of companies in the index, but in terms of market capitalization. Including this morning’s reports, we now have Q1 results from 202 S&P 500 members that combined account for 50.8% of the index’s total market capitalization.

Total earnings for these 202 index members are up +8.7% on essentially flat revenues (+0.7% growth rate), with 68.3% beating EPS estimates and 44.1% coming ahead of top-line expectations. This is weak performance relative to what we have seen from the same group of companies in the recent past.

The composite or blended picture for Q1, where we combine the actual results from the 202 S&P 500 members that have reported results to estimates for the remaining 298 index members, is for total earnings to decline -0.4% from the same period last year on -5.1% lower revenues. Stronger growth from the Finance sector has helped the aggregate (composite) growth pace. Excluding the Finance sector, total Q1 earnings would be down -4.5% on -5.6% lower revenues.

Sheraz Mian
Director of Research

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