Earnings Results - Solid Initial Q1

Earnings Results - Do Earnings Matter?

Earnings Results - Short answer to the question if earnings matter is “yes they do.” Earnings are the only thing that matters to stocks. Every factor that affects stocks only matters as much as it affects their future earnings.

The chart below makes it look like earnings don’t matter because multiples have spiked more that forward earnings estimates. That’s an incorrect assumption because multiples fell in late 2018 because traders thought earnings were going to crater this year. Stocks are simply reversing a mistaken correction.

So far, there is evidence that the predicted collapse in earnings isn’t going to happen. The stock market decline wasn’t rooted in reality so it recovered. Volatility in stocks can be higher than volatility in earnings. Stock prices are often driven by sentiment. It’s common to see overreactions. Also, it’s very difficult to determine where future earnings are headed. Which is why the consensus, represented by the price of the overall market, can be incorrect.

This rally in 2019 is being reviewed again because the S&P 500 is at a new record closing high. It’s not that investors aren’t always reviewing the market; it’s simply human nature to update published analysis after a major threshold is reached. 

Nothing has changed in the past few days other than a modest rise in stocks and some solid earnings reports. Heading into this earnings season, I stated results needed to be good because stocks rallied heavily to start the year. Traders repudiated the earnings estimate collapse in the first 2 months of the year. 

The rally has continued because traders were correct to go against the harshly negative revisions. This earnings season has been decent.

Earnings Results - Scorecard Keeps Improving

Every morning and afternoon earnings are being reported, so forgive me if you are reading this after a few more reports have come out. As of 9:30 AM on April 23rd, 79% of 104 S&P 500 firms have beaten their EPS estimates. The average surprise of 6.63% is much better than the 3 year average of 4.46%. 

EPS growth has been 6.17%. Since the surprise rate is greater than the growth rate, you can see initial estimates were for a slight decline. The FactSet numbers are a little bit worse.

If you’re basing your analysis on The Earnings Scout metrics, the earnings recession that was feared 2 months ago won’t occur. Estimates for Q2 earnings will probably fall negative in the next few weeks, but after results are reported and most estimates are beaten, EPS growth will end up positive. 

Estimates for the back half of the year probably won’t go negative as they have started out higher. 

Earnings Results - The direction of the economy will play a big role in the final results. 

It looks like the Chinese economy is turning around. That should help corporate profit growth.

As the middle section of the table above shows, 55% of the first 104 firms to report earnings have beaten their sales estimates. That’s 11% below the 3 year average. 

Average sales surprise was 0.83%. Sales growth was 4.27% which is solid given the tough comparisons. Remember, the big burst in EPS growth in 2018 wasn’t all because of the corporate tax cut. Revenue growth was high because the American economy had a good year, especially in the first 3 quarters.

So far, only 12 tech and communication services firms have reported results combined. This week will be key for those big sectors. Even if healthcare firms report great results, I don’t think the sector will rise because the worries aren’t about near term earnings. They are about the legislative potential changes after the 2020 election. 

On the other hand, tech and communication services stocks have risen because investors’ worries were about near term earnings.

Earnings Results - Chicago Fed Index Improves Slightly

The Chicago Fed index doesn’t support the optimism stock traders are showing. At least it isn’t consistent with a recession which investors feared when the yield curve partially inverted in March. The index increased from -0.31 to -0.15. 

March reading was the fourth straight negative one. 3 month moving average fell from -0.18 to -0.24. That’s the worst quarterly average since May 2016. Consumer spending and housing were in the negative column along with production and employment.

I expect housing to switch to the positive side this spring. Anytime a score is negative, it means it is growing at a rate below the historical average. In other words, we are in an economic slowdown. The only good news here is that the reading needs to be below -0.7 to be consistent with a recession. 

It’s questionable for stocks to rally this much just on the fact that the economy isn’t in a recession. Also, it’s clear that this report isn’t consistent with the Atlanta Fed’s forecast of 2.8% Q1 GDP growth. Finally, it’s closer to the blue chip average of 1.5% growth.

Specifically, personal consumption hurt the March index by 7 basis points and the production indicators hurt it by 12 basis points. Employment hurt it by 3 basis points and the sales, orders, and inventories category helped it by 5 basis points.

Earnings Results - Goldman Sachs Current Activity Indicator Improves

As you can see from the chart below, the Goldman Sachs current activity index is following the ECRI leading index higher. 

Global outlook has brightened since the start of the year. Annualized preliminary growth in the global index was 3.6% in April. 

As you can see, this index’s growth rate bottomed at a slightly higher growth rate than it did at the start of 2016. It seems like this slowdown isn’t as bad as the last one. Similarly, the Chinese current index’s growth rate has bottomed and is spiking. Its growth rate was 5% in December. In March it increased to 7.6%. It looks like the stimulus is working.

Earnings Results - Conclusion

Earnings matter and Q1 results have been solid as the EPS beat rate is above the 3 year average. Chicago Fed’s March index shows growth was below the long term average. 

Growth has been below average for 4 straight months. I’m looking for this index to switch to positive later this year. Goldman current activity index is showing growth has already started to rebound. It supports the Atlanta Fed’s prediction for 2.8% Q1 GDP growth. 

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