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Making Sense of This Market

Sheraz Mian

The market is juggling a number of balls, ranging from the seemingly never-ending trade/tariffs issue to worries about global growth and Fed policy. Treasury bond yields have become an excellent proxy for watching the interplay of all these worries in real time. And the relationship has been fairly straight forward, with the major stock market indexes going down as the yield on the 10-year Treasury bond goes down.

Treasury bond yields have long been a very good proxy for economic growth and inflation outlook, with down-trending yields typically indicative of the market’s weak growth and inflation outlook. But the current/ongoing downtrend in yields has more to do with Treasury bonds’ well-earned reputation for safety.

These instruments are not only risk free (from a credit risk standpoint), but also extremely liquid that makes it easy to get in and out. Investors, both local as well as foreign, flocking to Treasury bonds as a safety play in the current uncertain environment when the day-to-day market movement is driven less by fundamentals and more by something as hard-to-handicap as a Presidential tweet.

I have long been sanguine about the outlook for the U.S. economy and the eventual resolution of the trade issue. The way to deal with this situation is to tune out the noise and stay focused on long-term fundamentals of profitability, valuation and diversification, using every instance of panicky market selling to pick up quality stocks that are on your watch list. Timing the market is never easy and this has become almost impossible to do in the current topsy-turvy environment.

Trade & Earnings

There is little doubt that tariffs are bad for earnings. There is not only the direct relationship of higher tariffs weighing on margins, but also an indirect effect through reduced corporate confidence weighing on spending and investments.

Companies exposed to international trade have been making this point at every available opportunity this earnings season, from CSX Corp. (CSX) and Caterpillar (CAT) to even the big banks like JPMorgan (JPM) and others partly blaming the trade uncertainty for tepid growth in loan portfolios. We will likely hear more about the trade issue from companies reporting this week, ranging from Macy’s (M) and Wal-Mart (WMT) to Deere & Co. (DE) and chipmakers Nvidia (NVDA) and Applied Materials (AMAT).

In total, we have more than 250 companies reporting results this week, including 11 S&P 500 members. By the end of this week, we will have seen Q2 results from 462 companies or 92.4% of the index’s total membership. We have a couple of retailers reporting this week, but the earnings focus will solely be on the Retail sector in the coming days.

Our Take on the Q2 Earnings Season

The overall picture emerging from the Q2 earnings season is good enough; not great, but not bad either. The fact that there is not much growth is hardly news to anyone, as we knew all along the very tough comparisons for this quarter, as well as the remainder of this year. Earnings growth was essentially flat in the first quarter of the year and we appear to be on track for a similar performance in Q2 as well.

Here are the key takeaways from the Q2 earnings season after seeing results from 451 S&P 500 members through Friday, August 9th.

First, no major surprises on the growth front, which we knew will be anemic. We should keep in mind however that the growth challenge is more a function of tough comparisons to last year’s record results than a cyclical downturn in profitability.

Total earnings for the 451 index members that have reported are up +0.7% from the same period last year on +5.1% higher revenues. Earnings and revenue growth for the same cohort of companies had been +0.1% and +4.6% in the preceding earnings season, respectively. In other words, earnings and revenue growth is tracking modestly above what we had seen in the March quarter.

The comparison chart below puts this growth picture in a historical context for these 451 index members.

 

 

 

 

Earnings growth for the quarter was expected to be in negative territory before this earnings season got underway. But the blended growth rate, which combines the actual results that have come out with estimates for the still-to-come companies is for flat growth (0% growth to be precise) on +4.6% revenue growth.  This could change as we go through the remainder of this earnings season. But at least at this stage, Q2 growth is even with what we had seen in the preceding quarter.

Second, positive EPS surprises are about in-line with historical trends while the proportion of these companies beating revenue estimates is notably on the weaker side.

For the 451 index members that have reported results already, 75.6% are beating EPS estimates and 57.4% are beating revenue estimates. For the same cohort of companies, the proportion of positive EPS and revenue surprises was 77.4% and 61% in the Q1 earnings season.

The comparison charts below put the Q2 beats percentages in a historical context for these 451 companies.

 

 

 

 

Third, estimates for 2019 Q3 are coming down more than what we saw in the comparable period for the preceding two quarters, but about in-line with historical trends. The current -4.1% decline is down from -3.4% last week and -1% in mid-June.

The chart below shows how estimates for 2019 Q3 have evolved over the last five weeks.

 

 

 

 

Estimates for full-year 2019 are coming down as well, though the magnitude of negative revisions is a lot lower currently than had been the case at the start of the year.

Q2 Earnings Season Scorecard (as of August 9th)

We now have Q2 results from 451 S&P 500 members or 90.2% of the index’s total membership. Total earnings for these companies are up +0.7% from the same period last year on +5.1% higher revenues, with 75.6% beating EPS estimates and 57.4% beating revenue estimates.

For Q2 as a whole, total earnings for the S&P 500 index are expected to be flat from the same period last year on +4.6% higher revenues, which would follow the -0.1% earnings decline on +4.2% higher revenues in 2019 Q1.

The table below shows the summary picture for Q2, contrasted with what was actually achieved in the preceding earnings season.

 

 

 

 

The chart below the Q2 earnings and revenue growth pace in the context of where growth has been in recent periods and what is expected in the next few quarters.

 

 

 

For an in-depth look at the overall earnings picture and expectations for Q2 and beyond, please check out our weekly Earnings Trends report from August 7th.

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