Here Comes Q2 Earnings Season: Expect Stellar Numbers But Watch The Deterioration In Outlooks

Following a blockbuster Q1 earnings season in which EPS rose at the fastest pace since the financial crisis, yet which saw a surprisingly muted market reaction perhaps as a result of growing global protectionism fears coupled with rising rates, a slowdown in China and generally tighter financial conditions, traders turn their attention to the second quarter earnings season which officially begins on Friday the 13th.

As usual, the big banks are among the first to report, with Citigroup, JPMorgan, PNC Financial, Wells Fargo, Bank of America, and BlackRock all reporting results by July 16. In total, 87% of S&P 500 market capitalization will report 2Q results by August 3.

What to expect?

According to Goldman's chief equity strategist, while modestly below Q1's blockbuster 25% EPS increase, results are still expected to be strong, with consensus expecting 20% year/year EPS growth.

Here Bank of America's Savita Subramanian chimes in predicting that EPS will come in modestly better than analysts expect, hitting 22% YoY supported by very strong results from early reporters, positive (though decelerating) US data surprises, better-than-expected US GDP growth (which is tracking 3.6% in 2Q vs 2.3% in 1Q), and strong ISM indices.

With just days left until the start of earnings reports, Wall Street analysts are still revising up estimates; typically they cut estimates by around 3% in the prior three months. Sales growth is expected to remain healthy at 8% YoY (similar to in 1Q). A weaker average US dollar relative to the year ago quarter should contribute about 1ppt to YoY sales growth, and higher oil prices— WTI +40% YoY on average—should also benefit growth.

In some good news for the Fed, if not so good for corporate employees, while profit margins are forecast to expand by 88 bps to an all-time high of 10.9% - which suggests that wages continue to remain subdued, while limiting the "threat" of a wage induced inflation spike - this will be aided by a 14 pp reduction in the statutory corporate tax rate.

However, as Kostin notes, strong 2Q earnings growth is not just a function of lower corporate tax rates, as sales are also expected to rise by 11%, which would be the fastest pace of year/year revenue growth since 3Q 2011, thanks to a weaker average US dollar relative to the year ago quarter, as well as higher oil prices— WTI +40% YoY on average— should also benefit growth. Pre-tax earnings are also forecast to climb by 13%.

Drilling down on specific sectors, earnings are expected to rise in all 11 S&P 500 sectors, with Energy and Materials earnings growth set to pace the market at 135% and 40% year/year, respectively, largely thanks to the 16% YTD surge in Brent. Consumer Staples EPS is expected to be roughly flat year/year, but results in that sector and Health Care are complicated by CVS Health Corp’s recent acquisition of Aetna and subsequent sector reclassification, according to Goldman. Consumer Staples and Health Care EPS are also expected to grow by 8% and 9% in 2Q, respectively.

One question investors have is whether this earnings season will see the surprisingly muted response to earnings beats observed in Q1, while punishing those who missed. Goldman believes that this time around, investors will be more lenient, to wit:

We expect the prevalence of earnings beats will moderate from an impressive 1Q rate but the market will reward beats more. In 1Q, S&P 500 EPS grew by 24% (7 pp faster than consensus estimates) and 55% of companies beat consensus EPS estimates by at least 1 standard deviation, the highest level since 2Q 2010. A slightly weaker macroeconomic environment will result in earnings beats normalizing from elevated 1Q levels. However, firms beating EPS estimates outperformed S&P 500 by only 44 bp on the day after reporting, well below a historical median of 103 bp. One reason is that positioning was already long: our prime services colleagues’ net leverage data show that net length was above-average in 1Q reporting season. In contrast, net leverage recently fell below the 10th percentile vs. the last 12 months.

Additionally there is material room for upside, as analysts do not believe the conditions that led to strong 1Q beats will continue: as shown in the chart below, consensus estimates of 2Q, 3Q and 4Q 2018 EPS growth have barely changed since the start of 1Q reporting season.

And while Q2 earnings will hardly disappoint, traders will eagerly await guidance from management teams on two key issues, the strengthening dollar and protectionism in the context of escalating trade wars.

On the first, front, the USD weakened in 2Q vs. the year-ago period, but according to Goldman, its recent sharp rise suggests it could become a headwind to S&P 500 sales growth.

The trade-weighted USD was 3% weaker on average in 2Q 2018 than 2Q 2017, benefiting S&P 500 sales growth. Info Tech, Materials, and Energy are the three sectors with the largest share of sales from abroad and also rank as the top three sectors based on consensus estimated 2Q sales growth. However, the trade-weighted USD rose by more than 5% during 2Q, suggesting the dollar could become a headwind to exporters. Internationally-exposed stocks lagged in line with strength in the USD.

Which leaves tariffs as the biggest risk to market sentiment, although according to Kostin, the potential impact to aggregate S&P 500 EPS - for now - is limited given exports to China comprise just 1% of US GDP. Even so, despite their limited aggregate impact, tariffs will have a disparate influence at the stock level, especially on firms with high China sales and high reliance on imported COGS.

Morgan Stanley is less sanguine, and in a Sunday note from chief equity strategist Michael Wilson, the bank writes that "we do think that 2Q earnings season will bring an inevitable acknowledgement from companies that trade tensions increase the risk to forward earnings estimates, even if managements don’t formally lower the bar."

Bank of America echoes Moran Stanley's caution and tells clients to beware any deterioration in corporates’ outlooks...

This quarter we will be paying close attention to management guidance and commentary for any deterioration in outlooks driven by uncertainty around growth or trade, which could halt the capex recovery and stall confidence. So far, so good – management has continued to guide above analysts’ upwardly revised earnings estimates (Chart 5), and has also continued to guide above analysts’ forecasts for capex (Chart 6), though the capex guidance ratio fell to slightly below average levels as of our latest update in June.

... As well as further pressures from higher wages and input costs.

Companies who cannot pass through higher wages and/or input costs could also be at risk. 10% of companies cited higher labor costs in 1Q18 vs 8% in 4Q17 (the highest since we began tracking in 2015), and wage growth is at post-crisis highs (Chart 7). We have not seen a hit to margins yet, but operating margins have softened in Consumer Discretionary (the most labor-intensive sector) plus several others. We are monitoring our BofAML Corporate Misery Indicator (Chart 8), a macro proxy for profitability that has been strongly correlated with, and sometimes leads, the profits cycle. This indicator has been volatile in recent months, but wage growth has generally outpaced CPI. If it turns south, profits are likely to decelerate, and a margin squeeze could be in the works, unless demand and/or pricing pick up.

In conclusion, when it comes to the most important variable, namely how single stocks - and the broader market - will respond to Q2 earnings, the answer may not be found in either backward looking revenue and EPS numbers, or forward looking guidance, which changes day to day based on the macro picture, but what Trump may tweet at 6 am on any given day, and how China will respond. And those, as the past 6 months have shown, are completely unpredictable

 

Comments

takeaction Sun, 07/08/2018 - 17:58 Permalink

The fun will never end....from my viewpoint, I don't think "They" will let it fall.  No matter what chart, no matter what good news or bad....nothing is ever bad.  Metals will go sideways for eternity....This is the new world folks.  Don't worry about it...forget about it...and enjoy the day.  That is how Fuck'em.  

On a side note...

One Democrat employee now switching to Conservative....

Today I was talking to one of my Democrat employees...and his wife recently got a job working for the state.  She fields calls dealing with subsidized housing.  He is Hispanic and works his ass off, just like his wife.  Both have green cards. He has always bee a Liberal until now. 

He is telling me that his wife fields calls all day long form African Americans getting subsidized housing.  They receive$1000 to $1200 covered by the state in many cases and all they have to pay is $50. Their portion of the housing is $50.  The reason for their call is that they say "I CAN'T AFFORD $50".  They scream at his wife all day long demanding the state pay the other $50.  Can you believe that?  

Now my Democrat employee is saying things like 

"What is wrong with these people?"

"Do our taxes pay for these people?"

"How can this system work like this, and why do I have to pay for them?"

After I explained a few things...I said "Welcome to our side."  He laughed...and said..."I think you are right."

NOTE:In Oregon...along the FREEWAY...and at many stores all you see are huge "NOW HIRING" signs.  I have been looking for an electronics salesperson for over a year.  Can't find one.

Son of Loki takeaction Sun, 07/08/2018 - 18:04 Permalink

Retail is taking a bloodbath. Anyone see Big Store sales yet?

Disastrous from what i heard. Even online sales for apparel have to be way down. How many shirts does a person need esp when thousands of Chinese ships are offloading tons of the stuff every day. No wonder malls are going under (besides the out-of-control mall crime).

In reply to by takeaction

CashMcCall same2u Sun, 07/08/2018 - 20:23 Permalink

Ok you are a gold bug, I'm not. Only 1% of the world population trades in gold. The sum total of gold ever mined is worth 8 trillion dollars by today's dollar. That is not enough to cover any US Debt. Also gold has intrinsic value and nothing more. It is heavy difficult to store and can easily be stolen if you keep it at home and it is untraceable. 

By comparison and Buffett has made this, if you own farmland, it is capable of production. Gold produces nothing and doesn't even pay rent, a dividend or interest. It is 100% intrinsic. 

Finally, Gold did not save anyone during the Great Depression. In fact, Gold dropped significantly in 1931 then rebounded back to near $25 an ounce. 

For me, the age-old question is what is Gold actually worth. To you it is valuable to me it has no value other than intrinsic value which is what one sucker will pay another sucker to own it. 

Understand that if I thought there would be a lot of suckers wanting to buy gold at Tulip prices, I would gladly own some gold to make the sucker trade. I simply don't think gold is cheap and I don't see gold taking off even in a recession or Armageddon. 

In reply to by same2u

MusicIsYou Sun, 07/08/2018 - 18:07 Permalink

Looks to me that everything on the ground is coming unraveled, so it does not actually matter what the markets look like. The markets look great, but where are you going to spend all your money if an angry mob beats you over the head at a restaurant? I guess your money is just going to be some digit on a computer screen with no real world value. Of course you can always go {bury yourself alive} in some underground compound, and connect yourself to "Hal" and pretend you have a life.

same2u Sun, 07/08/2018 - 18:26 Permalink

Deterioration in the outlook? Author must be on drugs. Government deficit at 500 billions, Global QE in full force, tax cuts passed plus new ones coming, relationships with Russia, NK improving, etc...stocks are going much higher. Only bad outlook is for the bank accounts of those who refuse to play the game with the rules that are given to them...enjoy being right, but poor...

whatisthat Sun, 07/08/2018 - 18:53 Permalink

I would observe the nature and extent of  fortune 500 company books (10k and 10q documents) are likely cooked with corruption and misrepresentation and consequence....there is no such thing as a stellar earnings report.....

hotrod Sun, 07/08/2018 - 18:58 Permalink

The market is Nationalized like Japan. 

We replace a bellweather Dow 30 like GE with WallGreens and nothing said.

If you dont show proper earnings you get raided like CAT. IBM reduces Tax liability to get some earnings.

Facebook an easily recreated software application creates the 3rd richest man??????

Government is financializiing all sorts of ideas trying to achieve growth.

 

The nation is running but running in place

 

UNLESS WE GET A SPACE FORCE

 

 

 

 

everything1 Sun, 07/08/2018 - 19:14 Permalink

Wages up, rates down, fiat flush.  The call to invest in banks again is well over a year old now and they are definitely banking with RE finally up again and CC debt outstanding at a trillion?  Everyone and their brother driving new wheels.  Rates have only been this low three times in history, 1960, 2005?, and 2016 and from 2009 until 2015 ZERO.  Euroland, currently ZERO, Japan, Switzerland?, NEGATIVE.

It's going to take a long, long time for all this QE to play out, as this will be the longest bull run in modern history.  Big investors are already cycling into the safe zones, wherever those are?, bonds?, well ahead of time.  My friends who are retired?, they are not even tapping into their 401K's!

The next recession isn't going to start in the U.S., Euroland and Asia got us covered this time.  All that exporting inflation talk has not quite come home to roost, or has it.  Asia/China already raising their rates?, or starting to clean up bad debts as we clamber to cool or stimy the storm or repercussions of free money.  For the most part, interest rates in most countries are still at record lows.  Relax and enjoy the ride while it lasts.

 

 

Fantasy Free E… Sun, 07/08/2018 - 19:37 Permalink

All eyes are on the seasonal pattern of weakness in the fall. After struggling during July and August the most wonderful news possible will be released just as September rolls around. 

http://quillian.net/blog/promoting-your-own-poverty/

What will the good news be? The tariffs will be called off and the shorts will be squeezed all the way through October. This is politics, not a market. You can count on it. Granted, the plan may not work but the effort will be made and if it does fail this will be the first time.

CashMcCall Sun, 07/08/2018 - 20:04 Permalink

All one needs to do to understand this phoney claim of higher earnings, is look at how IBM attempted to "fix" its poor earnings and revenues over the last 20 quarters by including the Tax windfall as income. They got caught in the cheat but that hasn't stopped the market talking heads from exaggerating earnings. Of course Jim Cramer the guy that can't beat the S&P bouya... declared, "BIG BLUE IS BACK!" I regard that as a "Sell Sell Sell" conformation. 

But it is obvious these were pretend earnings not a fundamental or substantial change in the businesses productivity. In fact, productivity in MERICA has steadily declined over the year. That gives more reason to suspect surprises to the downside. 

Also be aware the Fed claims this will be a short-lived elevation of the GDP and it will fall the rest of the year. Last quarter you may recall how the talking heads at CNBC were climbing the financials bandwagon claiming earning would be blowout to the topside. The opposite happened and financials tanked. 

Remember that the financial press is owned. How many quarters during Obama did the CNBC cheerleaders say that every quarter was the expected big break out quarter... that never happened. 

I look for a brutal August this year as expectation erode extending all the way through January. There are simply too many large negatives converging. Once the earnings lies converge, and the Fed keeps tightening too long, and Trump continues to fumble with Tariffs claiming them as a negotiation strategy yielding losses, you will have market uncertainty and tightened liquidity. As they say in the markets... "Get scared, get scared early!"