7 Out Of 7 Firms Have Beat Q2 Earnings Estimates

Weak Existing Home Sales

The new home permits, starts, and completions were all strong in May, but the existing home sales have been flat at best this year. The seasonally adjusted annual rate of existing homes sales was 5.43 million in May. This was below the consensus for 5.5 million. As you can see from the chart below, the rate was 5.45 million in April. This means the month over month change was -0.4% which is on top of last month’s month over month decline of 2.7%. The year over year decline in existing home sales was 3%. Last month’s year over year decline was 1.6%.

Existing home sales aren’t growing like new home sales because they recovered quicker than new homes sales after the financial crisis. Existing home sales simply went up afterwards while builders of new homes were still licking their chops in 2010 and 2011. After many went out of business, it was a tough decision to start building again. Existing home sales are currently weak because of low supply, high prices, and high mortgage rates. The chart above shows mortgage rates have gone from 3.4% in the summer and fall of 2016 to 4.6% now.

The median sale price went up 2.7% month over month to a record high $264,800. The year over year increase was 4.9%. Even though supply was up 2.8%, it remains constrained. The supply to sales ratio increased from 4 months to 4.1 months. This report will hurt GDP growth again. The weakest region was the northeast which saw a decline of 11.75% year over year. The west was down 4.1%, the Midwest was down 2.3%, and the south, which is the biggest market, was flat.

Earnings Update

Even though earnings season doesn’t get going until the second week of July, which is in 3 weeks, there have been 7 firms which have reported their Q2 earnings so far. As you can see from the top table below, the results are a perfect 7 for 7 in terms of earnings beats. 3 tech firms, 2 consumer discretionary firms, 1 consumer staples, and 1 industrial firm beat estimates for an average growth rate of 29.81%. The average EPS surprise is 3.26% so far. The sales growth was slightly lower because one consumer discretionary firm missed estimates, making the beat rate 86%. The average sales growth was 12.38% and the sales surprise average was 0.92% above estimates. The average effective tax rate was 11.72%. The tax law changed the corporate tax rate from 35% to 21%.

Obviously, 7 companies reporting needs to be contextualized because you can’t just assume that’s how the whole quarter will play out. It’s likely that the numbers will come down. That’s not to say this isn’t a big positive because it is. The table at the bottom of this graphic compares these results with the past 4 quarters and the 3 year average after 7 firms had reported. As you can see, only Q4 2017 had a 100% beat rate; it’s average surprise rate was 5.7%. This quarter is better than the 3 year average in every category as the sales growth and earnings growth are about double the average. The decline in the earnings growth rate from last quarter is consistent with expectations as only Q3 should beat Q1’s growth rate.

Will The Yield Curve Not Matter This Cycle?

The late 1990s is an interesting point for the yield curve because it was debatably wrong about the next recession coming soon. The curve went negative for about one month in June 1998 and then steepened quickly to 60 basis points. The fear of a recession occurs when the curve inverts and then steepens sharply. Since the next recession was in 2001 and the bull market top was March 2000, you can say the indicator was dead wrong. The reason I say it was debatably wrong is because the inversion was very shallow as the 2 year yield was just 7 basis points above the 10 year yield and it was for a very short time. Those two points are unlike the period in the late 1980s before the 1990-1991 recession and the period in the mid 2000s before the financial crisis in 2008.

One other telling part of this 1990s cycle is that the curve flattened to just 9 basis points in December 1994, but then didn’t go negative until June 1998 like I mentioned. That shows how the current situation can easily switch. That level of steepening would lengthen this business cycle by a couple more years. Nothing is a given as the Fed could become more neutral or growth and inflation could pick up, steepening the curve.

The 1990s cycle is comparable to the current one in length, but growth was much quicker as productivity growth was spurred by the cheapness of semiconductors and the advancement of the internet. The final interesting part of this cycle is the curve peaked 2 months before the top in the stock market and went negative one month before the top. A few weeks after the top, the curve was severely negative as it was -52 basis points in April 2000. It’s interesting to see that even though the curve was very negative, it didn’t lead to a severe recession. It was a mild quick recession paired with a major crash in technology stocks.

The final point I will make on this topic is seen in the chart below. The red arrows show the flattening period in the mid to late 1990s which I just discussed. The rising ISM manufacturing index paired with the flattening yield curve signaled there was no recession coming. Now we have an even more optimistic ISM report with a flattening curve. For now, the curve doesn’t signal a recession, but this thesis will be put to the test if the ISM remains high and the curve inverts. It seems like common sense that there won’t be a recession in the next 12 months because growth is fantastic. The only negative I see is weakness in Europe and China.


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