Looking Ahead to Q2 Earnings Season

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The market’s focus is justifiably on the Fed this week given the buzz surrounding the ‘Taper’ talk. I don’t expect a categorical statement out of the FOMC on Wednesday, but it would not be unreasonable to expect Bernanke to provide more clarity on his thinking on the QE question in the post-meeting press conference that day.

The Fed will no doubt be the big subject this week, but we are getting close to the start of the Q2 earnings season as well. In fact, Q2 earnings season will actually get underway this week with the earning release from Discover Financial (DFS) on Monday, followed by reports from such bellwethers as FedEx (FDX) on Wednesday and Oracle (ORCL) on Thursday.

Alcoa (AA) typically gets credited for kicking off each earnings season, but we don’t count Alcoa’s report as the ‘official’ start; Discover will be the first 2013 Q2 earnings report in our tally. In fairness to Alcoa, investors start taking notice of the earnings season only with their release, which for Q2 will happen on July 8th.

As has been the case at the start of recent quarterly earnings cycles, expectations for Q2 earnings season remain quite low. Total earnings for companies in the S&P 500 are expected to be up only +0.6% from the same period last year. This is down from +3.9% growth expected in the quarter in early April. Total earnings were up +2.3% in Q1, but the expectation ahead of the start of the Q1 earnings season was for earnings growth to be in the negative territory.

Finance wasn’t a big driver of aggregate earnings growth for the S&P 500 in Q1, but takes back the lead role in Q2, with total earnings for the sector expected to be up +19.4% and estimates steadily going up. Earnings for the sector were up +7.7% in Q1, which came after many quarters of double-digit growth.

All industries within the Finance sector like the major banks, regional banks, brokers and insurers are expected to have positive growth. But the growth picture is particularly notable for the brokerage and investment management industry such as Goldman Sachs (GS) and Morgan Stanley (MS), with total earnings for the group expected to be up +39.6% in Q2 after the +2.6% gain in Q1.

Unlike Finance, the earnings picture for the Technology sector, the largest sector in the S&P 500, remains fairly weak. Total earnings for the sector are expected to be down -8.7% from the same period last year, which follows the -3.8% earnings decline in Q1.

Earnings estimates for the sector have been steadily coming down over recent weeks, with the current -8.7% decline down from expected decline of -3.1% in mid-April. The weakest group within the Technology sector is the PC makers, with total earnings for the Computers and Office Equipment industry expected to be down -16.1% in Q2 after the -14.1% decline in Q1. Semiconductors and electronics are other Tech industries with negative earnings growth in the quarter.  

Expectations for full-years 2013 and 2014 have come down far less than what we have seen for Q2 estimates. In fact, it is reasonable to assume that given the improving outlook for the Finance sector, aggregate estimates will start rising after a very long time in the coming weeks.

The +6.1% growth in total earnings this year, down from +6.8% in early April, reflects a material ramp up in the second half of the year that is then expected to carry into 2014. Combining the actual results for Q1 with estimates for Q2 gives us +1.5% year-over-year growth in total earnings in the first half of 2013. But total earnings are expected to be up +9.4% in the second half of the year and a further +11.5% in full-year 2014.

Trends in Estimate Revisions

The revisions trend appears to have lost some ground in the last two weeks, though the overall trend still remains in the positive-to-neutral territory. The charts below show trends in earnings estimate revisions. The key metric in all the charts is the ‘revisions ratio,’ which is the ratio of total number of upward revisions over the preceding four weeks to the total number of revisions (positive and negative) over that same period.

We have two charts each 2013 and 2014. The bar charts show the current state of the ‘revisions ratio’ (as of 6/7/13), while the line charts plot the ratio’s trajectory over the preceding 24 months.


 

The ratio doesn’t tell you the ‘magnitude’ of the revisions, only the direction. The ‘50%’ level (the dark line) is the dividing line between positive and negative trends, with readings above 50% implying more positive than negative revisions. Our analysis shows that readings between 45% and 55% don’t offer material insights into the magnitude of revisions. It is only readings above 55% and below 45% that offer bullish and bearish signals about the magnitude of earnings revisions.

As you can see in the charts above, the revisions trend for the S&P 500 as a whole is still in neutral territory, the current level (52% for 2013) is down from two weeks back (56% at the end of May). But the trend in the Finance sector continues to be in bullish territory for both this year and next (the blue line). The sector’s revisions ratio currently (as of 6/7) stands at 69% for 2013 and 73% for 2014, modestly down from two weeks back, but nevertheless signaling good times ahead for the sector.

The trend makes perfect sense as higher interest rates may be a hindrance for other industries, but it’s beneficial for the Finance sector’s earnings. Flat net-interest margins have been a permanent feature of the sector’s, particularly banking’s, earnings picture in recent quarters. The charts also show the trend in the Technology sector, the largest in the S&P 500, to spotlight Finance’s improving outlook.

The Finance sector’s positive earnings outlook is a function of the rising trend in interest rates. But whether that trend continues or reverses course in the coming days will depend to a large extent on what the Fed does this week. The consensus view is that the Fed may not do anything material in this week’s statement, but Bernanke may shed more light on the prevailing mood within the FOMC at his post-meeting press event.

Fed aside, we have a bunch of housing-related data on deck this week, including Housing Starts and Existing Home Sales data. We will also have the Empire State and Philly Fed regional manufacturing surveys and the May CPI numbers this week. But everyone will be looking ahead to the Bernanke press conference on Wednesday afternoon.

ALCOA INC (AA): Free Stock Analysis Report

DISCOVER FIN SV (DFS): Free Stock Analysis Report

MORGAN STANLEY (MS): Free Stock Analysis Report

FEDEX CORP (FDX): Free Stock Analysis Report

GOLDMAN SACHS (GS): Free Stock Analysis Report

ORACLE CORP (ORCL): Free Stock Analysis Report

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