Q4 Earnings Estimates Look Great
This has been a remarkable pre-earnings period because the estimates have only moved down 0.3%. As you can see from the chart below, the earnings estimate change has been the best since when they were increased by 0.6% in Q4 2010. Q4 2010 was when the economy was just recovering from the financial crisis which explains why estimates were increased as analysts started out cautious. You can see last quarter wasn’t great because analysts had to scramble to adjust for the negative impacts the hurricanes brought. This great Q4 pre-earnings period has occurred because 4 sectors saw an increase in expectations. The energy sector saw an increase in earnings estimates by 25.4% which was the best improvement since Q3 2005. Materials, technology, and utilities were the other sectors which improved. It’s interesting to see the sectors with the worst changes were consumer discretionary and industrials. There may have been a few firms which had a bad Christmas season. Industrials earnings growth going from 10.1% to 1.7% is surprising given the reports such as Markit and ISM which show the manufacturing industry is doing really well. The weakness is related to margins as the revenue expectation has improved from 6.2% on September 30th to 7.4% today.
Usually when the earnings estimates decrease throughout the quarter, they are setting up for a beat because the bar is lowered. This time the bar has barely been lowered. You can argue this means the beats won’t be large. This point has some credibility as Q4 2010 was expected to have 32.8% growth, but growth was only 19.5%. Q1 2016 had the worst pre-quarter drop, but results surprised to the upside as they came it at -6.7% which was better than the -8.8% expected.
One point worth noting is positive guidance has been strong. As you can see from the chart below, 30 companies have issued positive guidance which is more than the average which is 28. 75 firms issued negative guidance which is below the 5 year average of 80. I think these results would have occurred in Q3 if there weren’t two devastating hurricanes. Last quarter 44 firms issued positive guidance.
On the negative side, this positivity is already priced into the market as the S&P 500 was up 6.1% in Q4. If the great reports don’t start flowing, we could see a correction in the market. On the bright side, this earnings optimism shows this rally isn’t purely based on euphoria. There is excitement based on good results instead of being based on nothing like what occurred in tech stocks in the 1990s and cryptocurrencies today. A literal joke of cryptocurrency, dogecoin, reached valuation of $2 billion. Don’t be confused by the fancy whitepapers, these currencies are going up based on sheer speculation with no regards to fundamentals.
Great Pre-Announcements Don’t Mean Q4 Is A Slam Dunk
Let’s look at the historical results of earnings to see if the pre-announcements have relevance to the actual results. This is a realistic question because the average number of firms pre-announcing results is 110, meaning the other 390 firms might not be headed in the same direction. The results aren’t great, meaning the number of positive pre-announcements doesn’t have a high correlation to the surprises or the results. For example, the Q1 2015 pre-announcement period had only 19 firms reporting positive pre-announcements, but that quarter had a great surprise percentage as earnings were expected to fall -4.8%, but the actual result was 0.5% growth. On an overall basis, that’s not great, but the surprise was 5.3%. Q3 2017 had the most pre-announcements in the past 4 years, but the surprise was less than the Q1 2015 quarter as growth was expected to be 3.1%, and it ended up being 6.4%. This shows that the surprise percentage isn’t related to the positive pre-announcements. Furthermore, the earnings results also aren’t related to the pre-announcements since 2014 earnings were better than 2016, but 2016 had more positive pre-announcements. There seems to be a general trend toward more positive pre-announcements regardless of the results. This doesn’t necessarily mean the Q4 2017 results will be bad, but it takes away the argument that the pre-announcements mean Q4 will be great.
Energy Stocks Look Great
The biggest factor in this great pre-earnings period might be oil prices since energy saw the most improvement. Oil was in the $40s in Q3, but in Q4 oil was in an uptrend as it started in the high $40s and made its way to the high $50s. 2017 wasn’t a great year for energy stocks despite the increase in earnings and oil prices. This year is looking better as the XLE, which is an energy ETF, is already up 4.37% for the year. It’s up 21.65% since the bottom on August 21st. Interestingly, the energy ETF was at $76.59 in December 2016. Now it’s at $75.42. On the other hand, oil has increased from $54.90 to $61.46 in the same period. This suggests that even if oil prices correct in the next few weeks, energy stocks might still be a good trade.
The three factors at play for this sector are earnings, oil prices, and stock price performance. Energy earnings are growing quickly, but at a slowing pace because of base effects. The estimates have improved because of high oil prices. Oil prices are looking strong. On the negative side, the net long speculation is high and OPEC will be ending its cuts this year. On the positive side, demand is increasing and the end of the cycle is great for oil prices and energy stocks. Energy stocks look strong, but not as good as oil prices. Therefore, even if oil falls, you might still be safe with this sector.
Conclusion
The pre-earnings period for Q4 2017 has been amazing. Investors are looking forward to another great earnings season after Q3 was mired by the effects from the hurricanes. It’s not a slam dunk based on pre-announcements because they have been trending upwards regardless of the results. Energy might be a sector you should look at going overweight because they have underperformed oil and their estimates were raised considerably. The best scenario for the frackers is when oil prices are going up even as they increase production. That window looks like it will be open in 2018 as the demand for oil increases.
Recent Comments