Market Needs Earnings Catalyst
The following is an excerpt from this week's Earnings Trends article, to access the full article, please click here.
Stocks have stabilized a bit following the China-inspired whipsaw action on hopes that the domestic economic picture is strong enough to withstand China’s negative effects.
A major economic slowdown in China, beyond current market expectations, will have an impact on the global economy, including the U.S. economy. We can see that already in weak commodity prices. That said, the direct impact of a material Chinese slowdown on the U.S. economy will be a lot less severe than will be the case for many other regions.
Notwithstanding the transitory nature of some of the factors that gave us the strong Q2 GDP read, the outlook for the U.S. economy has been steadily improving. Readings about the labor market, housing and spending are all showing momentum, though the outlook for export-oriented manufacturing activities remains weak. The only uncertainty about the U.S. outlook is with the respect to the Fed - whether they will pull the trigger on the first rate hike next month or wait till December. The recent market turmoil appears to have increased the odds that the Fed may hold off in September and delay the lift-off decision to a later date.
Beyond the Fed, the market needs confidence in the corporate earnings picture, which has been very sub-par lately. Earnings growth in the Q2 earnings season, which is about to come to an end, was in the negative. In other words, total earnings for the S&P 500 index in 2015 Q2 were below the year-earlier level.
One could say that the actual earnings picture is somewhat better when the aggregate numbers are adjusted for the Energy sector drag and the effect of the strong U.S. dollar. Adjusted for these two factors, Q2 earnings for the S&P 500 would be up in mid-single digits, hardly enough to serve as a catalyst for the current jittery market.
Q3 Estimates Keep Falling
With the Q2 earnings season effectively behind us now, attention is shifting to the current period, particularly to trends in Q3 earnings estimates. On that front, we are seeing a continuation of the negative revisions trend that has been in place for a while now. Estimates for the current quarter came down as Q2 reports came out, and management teams provided weak guidance for the current period as well.
The chart below shows how earnings growth estimates for Q3 have evolved since the beginning of the quarter.
Total earnings in Q3 are expected to be down -5.5% on -4.8% lower revenues, with 9 of the 16 Zacks sectors expected to have lower earnings compared to the same period last year.
Q2 Scorecard (as of August 28th, 2015)
Including this morning’s reports, we now have Q2 results from 491 S&P 500 members that combined account for 98.7% of the index’s total market capitalization. Total earnings for these 491 companies are down -2.4% on -3.6% lower revenues, with 69.7% beating EPS estimates and 49.2% coming ahead of top-line expectations.
For the small-cap Russell 2000 index, we have seen results from 1837 index members that combined account for 94.0% of the index’s total market capitalization. Total earnings for these 1837 Russell 2000 members are down from the same period last year -1.3% on +1.8% higher revenues, with 50.4% beating EPS estimates and only 36.4% beating sales estimates.
The chart below compares the growth rates and beat ratios for the 491 S&P 500 members that have reported results with other recent quarters.
We know that Energy has been a big drag on the aggregate growth picture. Excluding the Energy sector, total earnings for the S&P 500 index would be up +5.0% on +1.1% higher revenues. But the growth comparison would still be unfavorable when we look at the results thus far on an ex-Energy basis, as the side by side charts below show.
As weak as the aggregate growth picture for the S&P 500 index is, the situation isn’t that much different for the Small-cap Russell 2000 index. The chart below compares the growth rates and beat ratios for the 1837 Russell 2000 members that have reported results with what these same companies had reported in other recent quarters.
Looking at the earnings performance of the S&P 500 and Russell 2000 index at this stage, we see growth challenges in both places, with positive revenue surprises even more hard to come by in the small cap index. This runs counter to the conventional view of the small-cap players being better placed relative to the large-cap multinationals in the S&P 500 on account of their greater orientation to the domestic market.
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