Previewing The Q4 "Hail Mary" Earnings Season
Q2 earnings seasons is now (with 93% of firms reporting) over, and it is time for post mortem. The bottom line for those strapped for time is the following: In order to salvage the 2012 earnings consensus for the S&P, the sell side crew and asset managers, as wrong but hopeful as ever, are now expecting Q4 2012 earnings to grow 15% versus 4Q 2011, which is more than twice as fast as any other quarter. Indicatively, Q2 2012 earnings rose at a rate of 3% compared to Q2 2011. Elsewhere, revenues came 2% lower than consensus estimates at the start of the earnings season.
And the kicker: The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. This number will certainly drop more and will be the first Y/Y EPS decline since the Lehman failure.
In other words, the entire year is now a Hail Mary bet that in Q4, the time when the presidential election, its aftermath, as well as the debt ceiling and fiscal cliff acrimony will hit a peak, a Deus Ex Machine will arrive and lead to a 15% rise in earnings. Why? Because global central bankers will have no choice but to step in and thus lead to a surge in EPS multiples even if the underlying earnings are collapsing. With the presidential election around the corner making Fed QE before 2013 now virtually impossible, with Spain (and Italy) refusing to be bailed out and cede sovereignty thus precluding ECB intervention, and with China spooked by what may be a surge in food costs, this intervention, and any hope that the Hail Mary pass will connect, all look quite impossible.
As the chart below shows, in this bizarro market, the lowest 2012 consensus earnings to date can only be matched by the highest PE multiple. Brilliant.
2Q earnings results disappointed across the globe. In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high. The divergence between trends in earnings and valuation is likely to become more pronounced as profit forecasts continue to be reduced in the coming months. In the US, our 2Q earnings season takeaways are: (1) disappointing sales; (2) in-line earnings; (3) margins are still declining; (4) 3Q estimates imply no growth while 4Q estimates imply significant growth; (5) earnings estimates are falling, driven by Energy and Materials.
2Q results by geography
For the US, sales disappointed more than earnings. 18% of ex-Financials and Utilities companies have posted positive revenue surprises by beating consensus sales expectations by at least one standard deviation, half the historical average. The number of firms that missed sales estimates was twice the historical average. Sales surprises were the worst since 1Q2009. The frequency of earnings beats and misses are largely in line with history.
In Europe, earnings season misses were driven by margins not sales. 239 companies, 54% of market cap, have reported. So far, the frequency of earnings beats, a surprise of 5% or more, is below the three-year average (33% vs. 43%), and misses are slightly higher (40% vs. 37%). Sales results have been modestly positive. Analysts significantly revised down Banks earnings. FY2012 estimates are down 9% over the past month.
In Japan, companies reported further earnings declines. 90% of TOPIX companies (95% of market cap) have reported earnings. Results so far have been disappointing especially in context of the April-June 2011 quarter. Last year, supply chain problems following the March 2011 earthquake resulted in a weak earnings season. Yet operating earnings for the April-June 2012 quarter are down 7.4% year over year. Revisions and guidance have remained muted, which our Japanese strategists see as a sign of caution in the face of macro uncertainty going into 2H.
Across Asia, Consumer Discretionary companies posted stronger results relative to consensus estimates. Similar to results in the United States, Energy and Materials posted the weakest results relative to consensus estimates. Singapore posted the strongest results relative to consensus while Taiwan was weaker.
In the US and Europe, P/E multiples have expanded more than fund managers might realize because earnings estimates are too high.
1. Global EPS forecasts are too high. Our top-down, full-year earnings forecasts imply further downside to consensus estimates in the US, Europe and Japan. In each region, the difference between our top-down 2012 EPS growth forecast and bottom-up consensus growth is about 3pp. Our MSCI Asia Pacific ex-Japan earnings growth estimate is in line with consensus.
2. In the US and Europe, P/E multiples have expanded more than fund managers realize. The strong rally in global equity markets during the past five weeks means portfolio managers have re-rated stocks based on policymaker promises rather than fundamentals. On consensus NTM EPS, the S&P 500 P/E multiple expanded from 12.6X to 12.9X. The Stoxx multiple rose from 10.0X to 10.7X over that same period of time.
3. Consensus earnings estimates declined in all regions over the last month. Full-year 2012 estimates fell 4% for the Stoxx 600 while Topix (FY) and MSCI AP ex Japan forecasts each fell 3%. S&P 500 estimates fell 1%.
4. Meanwhile, despite weak earnings season, the S&P 500 is up 3.6% since July 6. Other global indices have also rallied sharply with Stoxx up 6.2% and MSCI Asia Pacific ex Japan up 4.0%. TOPIX is down 2.6%.
Details of 2Q earnings results for S&P 500
A total of 456 firms in the S&P 500 have now released 2Q 2012 results representing 93% of the equity cap. Below we highlight our takeaways:
1. Sales disappointed. Realized sales are 2% lower than consensus estimates at the start of the season. 2Q2012 sales for S&P 500 (excluding Financials and Utilities) grew by 3% year over year.
2. Earnings in line with expectations. S&P 500 realized 2Q EPS is tracking at $25.49, a 2% positive surprise versus the consensus estimate at the start of reporting season. On a quarterly basis, 2Q2012 EPS will post year over year growth of 3% vs. 2Q2011. Telecommunication Services and Financials EPS grew by 26% and 14%, respectively. On a trailing four-quarter basis, 2Q2012 will establish a new EPS peak of $99.
3. Margins beat, but LTM margins are declining. With earnings beats and sales misses, 2Q quarterly margins are 20bp higher than expected (9.1% vs. 8.9%). Year over year, quarterly margins are flat to negative in most sectors. The trailing-four-quarter net margin for the S&P 500 is tracking at 8.8%.
4. Earnings expectations are falling and 3Q estimates imply no growth. The S&P 500 bottom-up consensus EPS estimate for 3Q fell 4% during the past five weeks and management guidance has been more negative than usual. Consensus expectations imply no earnings growth for the S&P 500 versus 3Q2011. Energy and Materials are the most significantly negative.
5. Over half of consensus 2012 EPS growth is from strong 4Q forecasts. 4Q earnings are expected to grow 15% versus 4Q2011, more than twice as fast as any other quarter. 4Q2011 growth was about half that of the other 2011 quarters, which explains some of the growth discrepancy between quarters in 2012. Analysts forecast a sudden jump in LTM margins to a new peak of 9.0% in 4Q2012 while we forecast further slippage to 8.7%.