Q3 Earnings Growth Is Expected To Be 22.61%

Q3 Earnings and market correction may not necessarily go hand in hand.

Q3 Earnings - Those claiming a 40% or great correction is coming are suffering from recency bias. The market is healthy despite the worries about this being the longest bull market in American history.

The failed analogy to gravity in that ‘what goes up, must come down’ will only cause you to miss out on the gains. The chart below shows the increase in Q3 profits has accounted for 70% of the gains since Q1 2010.

For all the talk about buybacks powering this rally, only 6% of the gains are from share reductions. Profits power share reductions, unless they are funded by debt which is a big red flag.

 

Q3 Earnings and valuations are related.

Valuation increases have been responsible for 24% of the increase in stocks. Keep in mind, stocks were fairly cheap in Q1 2010.

The forward 12 month PE in Q1 2010 was in between 13 and 14 which is below the 10 year average which is above 14. Stocks became much cheaper soon afterwards when analysts realized they were too bearish because the recovery had started.

Even the CAPE was only 19.92 in February 2010. That’s below where has been recently, but above the all-time average of 16.55. Many analysts, including myself, are skeptical of including data from the 1870s in the CAPE average.

The world is completely different from them. It seems silly to sell stocks now in part based on how they were valued over 100 years ago.

Update On Q 3 Earnings Expectations

Q2 earnings season is mostly over as 459 of the S&P 500 firms have reported earnings. This means buybacks can get back to their record pace and investors can focus more on economic metrics to gauge where stocks are going. Earnings estimates always matter. Economic reports can signal where the estimates will go.

80% of firms have beat earnings estimates on 26.4% growth and 74% of firms beat sales estimates on 10.8% growth. The 2nd quarter was even better than the first quarter.

The table below shows the historical changes to Q2, Q3, Q4, and Q1 2019’s earnings estimates.

Even though Q1 2019 earnings growth will sharply decelerate from Q4 because of a tough comparison, it is still above trend growth which is in between 6% and 8%.

These Q2 reports have pushed it above that range again. The estimate was pushed down by the great Q1 2018 results because Q1 2019 will be lapping those results.

I’m skeptical that full year 2019 earnings growth will be above 8%, but that doesn’t make me bearish. I believe you need to expect earnings to fall to be bearish.

Sometimes even when earnings fall stocks are up. Earnings growth of 5% wouldn’t be enough to catalyze a bear market.

Q3 Earnings flashbacks: Earnings fell in 2015 and 2016 and the S&P 500 still avoided a bear market.

According to FactSet, estimates for 2019 earnings imply 10.3% growth. It’s very important to avoid being bearish if your thesis is like mine which is growth won’t reach that level. Stocks have risen throughout this bull market while estimates have fallen.

You need to come up with a catalyst which explains why earnings will fall. Since I don’t have one, I’m neutral.

Keep in mind that Q3 is likely going to be a spectacular quarter which might push up 2019 expectations further. I have my eyes on 2019, but there’s no reason to sell before a major positive catalyst.

Q 3 Earnings - Don’t Obsess Over Multiples

Q3 Earnings - During the Turkish crisis, investors temporarily lost focus on the fundamentals as the media promoted the concept of contagion. You can also say that it was an excuse to sell off because the market was overbought.

Saying the market is overly extended is a short term point which has no place in long term analysis unless you are referring to an expensive stock market.

When it comes to valuations, investors too often shy away from high multiples. The correct strategy is to figure out why multiples are high and then see if the catalyst for high multiples is sustainable.

It’s completely wrong to be obsessed with multiples without contextualizing the data. By analyzing why multiples were high, I’m not saying that you should automatically buy into expensive markets which are euphoric. I’m saying you need to realize your ‘discovery’ of high multiples is meaningless because anyone can do the simple arithmetic calculation to determine the multiple.

Q3 Earnings Strategy: Even back testing returns after stocks are expensive isn’t enough.

Usually stocks are at least somewhat expensive at cycle peaks and relatively cheap at the troughs, but knowing that doesn’t add any alpha to your investing.

Missing out on years of gains means avoiding the losses eventually doesn’t help you outperform the market. For example, if you sold your S&P 500 index funds on July 17th, 2015, you lost out on 33.23% of gains since then.

If stocks fall 40% today, you would have avoided half of the losses if you buy stocks back at the exact bottom. Each percentage point the market rallies, the less you would have saved by selling in July 2015.

Keep in mind, it’s a big leap to claim stocks will fall 40% in the next recession because corporations and households have deleveraged this cycle. It’s also very difficult to time the bottom of a volatile market.

Because bears won’t perfectly time the bottom, it’s more than likely that selling in July 2015 was a terrible mistake even if there is a big crash at the end of this cycle.

Q 3 Earnings - Conclusion

We’ve seen stocks rally while earnings estimates fall this cycle. We’ve in the midst of the greatest earnings growth run this cycle outside of the post recession growth which had very easy comparisons. When stocks get overbought or there are negative catalysts, it means you should lighten up your holdings, not short stocks.

5% 2019 earnings growth wouldn’t cause stocks to fall into a bear market, so it’s probably best to avoid shorting the market unless you see a huge negative catalyst that me and the rest of the market are missing.

 

 

 

 

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