Big Earnings Week Ahead For Tech

Q3 Earnings Look Great So Far

This is the first week where earnings summaries include a significant portion of reports from Q3. As of the end of last week, 17% of S&P 500 firms reported earnings. According to S&P Dow Jones, the insurance firms’ hurricane weakness caused Q3 financial sector earnings to fall from $7.04 to $6.17. Last year’s earnings were $7.00, so this will be a sharp decline of 11.9%. The claims on insurance are expected to have a $0.75 effect on total S&P 500 earnings which still allows it to hit a record. However, the effect won’t only come from the insurance industry; it might not be a record if other sectors also have more of an impact than expected. On an as reported basis with 21.5% of reports in, the bottom up Q3 blended earnings are expected to be $28.33. The previous record was $27.47 in Q3 2014.

Looking at the earnings break down, this is the 3rd to last quarter where energy will have easy comparisons. Energy is expected to make a 3.63% contribution to S&P 500 earnings in Q3 2017 which is much better than the 0.92% contribution it made in Q3 2016. Technology is also taking a big step up this quarter as 21.77% of earnings will be from that sector which is above last year’s 18.48% contribution. Because of the weakness from insurance providers, financials are expected to have a 16.71% contribution which is down from 21.07% last year. In Q2 the S&P 500 had operating margins of 10.14% which was 4 basis points above the record. This quarter is expected to have margins of 10.36%. It is being dragged down by financials. The margins from the big tech firms will determine what Q3 looks like. This is a big week as Twitter, Amazon, and Alphabet are all reporting. The iPhone X will be available for pre-order on Thursday and will go on sale on November 3rd. It’s the biggest product launch of the year when looking at all S&P 500 firms.

Out of the 87 firms which have reported earnings in Q3, 67 beat expectations, 11 missed, and 9 met expectations. 60 out of 86 firms beat sales estimates. As per usual, the financial sector has the most firms which have reported so far. 25 financials have reported, with 20 beating, 2 missing, and 3 meting expectations. 17 firms in the industrials sector reported earnings with 13 beating, 2 missing, and 2 meeting expectations. The chart below compares Atlanta Fed GDP Now estimates for final demand with the S&P 500 industrials enterprise value to trailing twelve month EBITDA. As you can see, there has recently been a sharp divergence, meaning the stocks are expecting a sharp pickup in demand. If it doesn’t occur, the stocks will fall. While it’s possible the latest GDP Now estimate could be wrong, it already has GDP growing at 2.7% which is above the blue chip average, so it’s doubtful it’s too pessimistic.

As you can tell from the S&P Dow Jones results, this has been a great quarter thus far. Let’s now look at what FactSet has reported. As you can see from the chart below, FactSet calculated the number of firms which mentioned tax reform in their earnings calls to date. As you can see, there has been a spike in Q3, bringing it closer to Q4 2016. The chatter has intensified, but stocks with high tax rates show nothing is expected in the near term. The PredictIt betting market has the chance of an individual tax cut being passed by the end of the year at 34% and the chance of a corporate tax cut by the end of the year at 24%. Even if only individual taxes are cut, it would still benefit S&P 500 earnings because of the increase in disposable income consumers would have.

As you can see from the chart below, the FactSet comparisons for year over year earnings growth are much lower than the S&P Dow Jones ones. S&P Dow Jones has earnings improving 11.6% while FactSet has earnings only improving 1.7% year over year. S&P Dow Jones tends to have numbers which are more volatile, while FactSet’s numbers are normalized. As you can see, the financials are the worst sector because of hurricane weakness. Earnings are expected to fall 10.1% year over year. That’s close to the 11.9% decline seen in the S&P Dow Jones numbers.

Even though Q3 looks bad, there has been no decline in Q4 estimates. It looks like the market was right to be optimistic as the Q3 weakness isn’t bleeding into other quarters. If this is the case, the trailing price to earnings multiple will start including a quarter which was only weak because of the weather. That means it will be a less valuable stat starting in a few weeks after earnings season is over. When the bears claim the S&P 500 PE multiple is too high, the bulls can say earnings were temporarily pushed lower by a one time event. Obviously, there’s still room for disappointment as this week will be critical to determining the health of corporate earnings.

Fed Vice President

Last week, PredictIt started a betting market for who will be the next Fed vice chair by the end of the year. The website has John Taylor as a front runner with 25% odds and Warsh in second place with 7% odds. This shows that the pick will likely be a hawk. That would imply less continuity within the Fed because Powell is more of a dove. Usually the vice chair doesn’t have a big impact on policy, but it would be interesting to see Powell and Taylor or Warsh co-exist since they have major disagreements on policy. The job of the chair is to get all the FOMC members on the same page when voting. Normally, the vice chair would help in this process, but if it’s Warsh or Taylor, that probably won’t happen. Warsh or Taylor wouldn’t be able to sway policy, but they would cause the Fed to appear disheveled as there would be different voices singing different tunes. It would be like if VP Pence disagreed with President Trump often. This could bring volatility to the markets.

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