Haven't bothered to check in on the third quarter earnings season (which at this rate will mark the first two back-to-back quarters of earnings declines since 2009 [8], aka an earnings recession)? Then here is the 4 word summary from Goldman Sachs: "adequate earnings, dismal sales."
With results from 341 companies (77% of total market cap) in hand, the 3Q reporting season thus far can be summed up as simply as “adequate earnings, dismal sales.” Earnings have been in line with history, with 48% of firms surprising on the bottom line (above the historical average of 46%), for an average EPS surprise of 4% versus the historical average of 5%. On the other hand, sales results have been disappointing, a function of slowing economic growth and a stronger dollar. Just 21% of companies beat consensus revenue estimates by more than one standard deviation, well below the 10-year average of 32%. Excluding Energy, 49% of companies has surprised on EPS, while 20% has surprised on the top line.
If companies beat on earnings do they also beat on revenues?
Stocks delivering positive sales surprises have been more likely to surprise on earnings, but a top-line shortfall has not necessarily led to a bottom-line miss. 21% of firms has posted positive 3Q sales surprises, while 14% of stocks beat on both the top and bottom line, meaning firms that beat on sales were also likely to beat on earnings (see Exhibit 1). Stocks surprising on both the top and bottom-line include AMZN, JNPR, NOC. Interestingly, 71% of companies that beat on earnings either negatively surprised on revenue, or reported sales results in-line with expectations, suggesting that margins have surprised to the upside thus far.
So as corporate teams seek to push margins even higher in the coming quarters, there will be even more layoffs in the coming quarters, and even more disappointing employment numbers... which is great news for a "lower for longer" addicted market.
What is the cause of the ongoing revenue slowdown, aside from lack of capital investment of course? The strong dollar is the biggest culprit, a dollar which keeps getting stronger.
FX headwinds and a slowing US economy have caused positive and negative revenue surprises to diverge significantly from historical averages. Through the first 22 days of 3Q earnings season, only 21% of companies has positively surprised on revenue, nearly 12 percentage points below the 10-year average at this point in the earnings season. Around one third of S&P 500 companies have disappointed on revenue, significantly above the 21% average (see Exhibit 2).
Historically, as positive sales surprises become scarce, investors are more likely to reward beats on the top line (see Exhibit 3). This trend has been evident during 3Q reporting season. 73% of companies surprising on revenue outperformed the S&P 500 the day following the announcement, the second best hit-rate in the past decade. 3Q sales for NKE, which was aided by surprisingly strong revenue growth in China, beat consensus expectations and subsequently outperformed the S&P 500 by nearly 900 bp during the following day. In contrast, companies surprising on earnings have outperformed the market 64% of the time.
For those wondering if the weak top line number means a slowing economy, the answer is yes.
Disappointing sales results reflect below-average 3Q economic growth. GDP growth equaled just 1.5% in 3Q. Solid growth from consumer-facing sectors was offset by a drag from inventories. While real personal consumption expenditures increased by 3.2%, inventory accumulation subtracted 1.4 percentage points from growth.
It's not bad news for all though: the biggest companies will survive and will likely get even bigger.
Company results thus far suggest the largest S&P 500 companies have weathered the challenging growth environment better than their smaller counterparts. 58% of S&P 500 market cap has positively surprised on earnings versus an equal-weighted average of 48%, implying better-thanexpected results from larger companies. In fact, 66% of the 50 largest companies in the S&P 500 has beat earnings expectations versus 45% for the remainder of the index. 32% of the 50 largest companies beat on sales versus 19% for the remainder of the S&P 500 (See Exhibit 4).
... something the market has noticed and rewarded.
Better-than-expected earnings results for larger companies have coincided with large-cap outperformance. As measured via the Russell 1000 versus the Russell 2000, large-cap stocks have outperformed small-cap stocks by 257 bp since the end of 3Q. Looking beneath the surface, Consumer Discretionary and Health Care sectors in the Russell 1000 have crushed the Russell 2000 sector indexes, both by more than 400 bp.
[9]
Finally here is the full sector and industry performance broken down in various periods:
[10]
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Finally, this is where Goldman sees the S&P trading in 1 year: "We expect the S&P 500 will likely trade at 2075 in 12 months (-0.7%)."