Third quarter earnings season is underway, so it’s time to look under the hood.
A wide gap between S&P 500 profits and the broader NIPA measure from the BEA supports a late-cycle view.
The late-cycle view is also supported by weakening leading indicators.
Today’s report will be two-pronged. In addition to being in the midst of third quarter earnings season, we also got the latest Leading Economic Index (LEI) from The Conference Board on Friday. Let’s start with earnings.
The table below comes from Refinitiv—one of the most widely-followed sources for consensus earnings estimates—and includes earnings for all 11 S&P 500 sectors, as well as the index itself. The first column shows full year 2018; which obviously saw very strong earnings courtesy of corporate tax cuts. Even before accumulating additional hits to earnings in 2019 such as tariffs and weak global growth; there was an inevitable “base effect” problem for 2019 in that earnings were being compared to the tax-boosted year of 2018.
Source: Charles Schwab, I/B/E/S data from Refinitiv, as of 10/21/2019.
The “good” news is that heading into both the first and second quarters of this year, expectations were that S&P 500 earnings would be in negative territory on a year/year basis; but ultimately the bar was set low enough for companies to collectively eke out a gain. As you can see above, the weakness in earnings over the past three quarters has been concentrated in the energy and materials sectors; but even the technology sector has been in the red.
So far this reporting season, the year-over-year “blended” (reported plus expected) earnings growth estimate is -3.1%; with a better -0.6% if the energy sector is excluded. Of the 75 companies that have reported earnings to date for the third quarter, 82.7% have beaten estimates and 12% have reported below estimates. In a typical quarter (since 1994) 65% of companies have beaten estimates, with 20% missing. The caveat is that the beats tend to come earlier in the reporting season; so it’s likely the beat rate will come down.
It’s not just the difference in earnings growth rates between this year and last year that’s distinctive. It’s also what happened to P/E multiples each year. In essence this year has been the mirror image of last year; as you can see in the chart below.
2019 Mirror Image of 2018
Source: Charles Schwab, I/B/E/S data from Refinitiv, as of 10/21/19.