Across the Pacific, US investors are transfixed by the second-quarter (to June 30) reporting season, which gives the tale of the tape for US companies at the halfway point of their financial year.
The earnings season is far from complete – just over one-quarter of the companies in the S&P 500 (that is, 126 companies) have reported second-quarter earnings so far – but the theme is definitely one of better-than-anticipated earnings, which has helped to keep US markets on an upward trend.
In fact, the broad S&P 500 index closed at record high on Friday.
According to financial data provider FactSet, the S&P 500 sample so far has seen 68% of companies report earnings above the average analyst’s estimate, and 57% announce sales above the average estimate.
US financial media are obsessed with this figure, which is known as the “beat rate.” But success or failure compared to the analysts’ estimates depends on where the analysts have set their expectations. And analysts have been dialing down expectations – but not by as much as normally. Earnings estimates for the current quarter have been cut by just 2.8%: over the past ten years, notes FactSet, average downward revisions were almost twice as high.
Also, the number of companies pre-announcing upwardly revised earnings guidance is at its highest level in five years, while the number of downside pre-announcements is running at its lowest level since 2011.
Coming into the June-quarter season, Thomson Reuters collated analysts’ forecasts and predicted that earnings per share (EPS) for the S&P 500 companies would come in down 4.7% on a year ago, following a 5% drop in the March quarter.
Companies’ revenue was also expected to fall, by 0.8%, which would represent the sixth straight quarter of declines, according to Thomson Reuters. That would actually be more of a worry to the US stock market than the so-called “earnings recession.”
US companies’ performance has been even weaker than these numbers suggest. Corporate share buy-backs rose to their highest level ever in the first quarter of 2016, according to S&P Dow Jones Indices: by reducing the number of shares on issue, buybacks tend to increase EPS.
However, analysts are gaining in confidence that the earnings recession may be coming to an end. Thomson Reuters forecasts 1.5% growth in profits for the third quarter (September) and a heady 9.1% for the final quarter (December.) Such an outcome would mean that the current reporting season showed the bottom of the earnings recession.
In theory, the US market should not have been rising: falling earnings is not normally a recipe for share price appreciation. In financial theory only two things move stock markets higher: rising corporate profits or for rising valuation multiples. It is the latter that explains the fact that the US market is looking expensive: going into the June-quarter reporting season, the S&P 500 was trading on 16.6 times expected 2016 earnings, according to FactSet, well above its five-year (14.6) and ten-year (14.3) averages.
What has driven multiples higher is not even faith that corporate profits will turn: It is the “TINA” trade – as in, ‘There Is No Alternative’ to stocks in a low-yielding world. There is now US$13 trillion of negative-yielding debt around the globe. US Treasury bond yields are at historic lows (that is, the bond prices are high), having recently traded below 1.4% yields, as investors frightened of global turmoil seek “safe haven” assets.
These paltry bond yields – let alone negative yields in Europe and Japan – effectively force investors into stocks, driving stock indices higher. The indices need demonstrable earnings recovery to justify their lofty valuations – if they do not get this, they are increasingly vulnerable to any sudden market shock.
That’s why this earnings season is being watched so closely.
Highlights of the US season so far have been:
- General Motors: the auto giant reported adjusted earnings up 44%, to US$1.86 a share from $1.29 a year earlier, exceeding the estimate of $1.52. Sales also shattered expectations, and the auto maker now predicts it will make as much as $6 a share for the year, 25 cents higher than the top of its previous forecast range.
- eBay: the online auctioneer surged 11% after beating estimates on both EPS and revenue, and upgrading its third-quarter guidance
- Alcoa: the 128-year-old aluminium producer, which is about to split into two companies, reported earnings that beat the consensus forecast by two-thirds.
- Bank of America Corporation: the second-largest US bank by assets saw its EPS fall by 16%, but at 36 cents, the second-quarter number beat the consensus forecast by 9.1%.
- Morgan Stanley: the financial heavyweight reported $8.9 billion in revenue (down 9%) and EPS of 75 cents (down 12%). At first sight, these looked bad numbers, but they significantly exceeded analyst estimates of $8.3 billion in revenue and EPS of 60 cents.
- Microsoft: the software and cloud-computing giant reported EPS of 39 cents a share, a stark turnaround from the loss of 40 cents a share for the same period a year earlier. Growth in cloud computing was a major contributor to the performance: quarterly cloud revenue more than doubled. Microsoft surged 6.9% to $US56.75 on the result, boosting all three major indices (the S&P 500, the Dow Jones Industrial Average and the Nasdaq Composite).
- IBM: the tech heavyweight’s overall revenue fell by 3% and profit fell by 29%, but the market liked 12% revenue growth from the company’s “strategic imperatives” businesses (cloud, analytics, mobile and security), the basis for IBM’s ongoing transition.
- Johnson & Johnson: the global diversified healthcare products maker reported quarterly EPS, excluding one-off items, of $1.74 per share, beating the consensus forecast of $1.68, and sending the shares to a new record high of $125.75.
- Qualcomm: the wireless chipset maker reported revenue of $6 billion, versus $5.8 billion a year ago and the consensus estimate of $5.6 billion, and EPS of $1.16, up from 99 cents a year ago and well ahead of the consensus forecast of 97 cents.
There have been lowlights as well, such as Netflix tumbling 13% after reporting weaker-than-expected subscriber growth; Starbucks falling short of earnings expectations, Intel reporting slower growth in its server-chip division, and American Express reporting revenue that was short of predictions.
This week the largest US stock – and technology bellwether stock – Apple reports, and according to FactSet, analysts on average expect Apple to report EPS of $1.40, down from $1.85 a year ago.
The future outlook statements are also being watched closely. The recent Brexit vote in the UK has thrown predictions into turmoil: analysts now expect that companies will use Brexit to lower their future earnings guidance for the September and December quarters, mainly on the back of currency volatility and the higher US$. Goldman Sachs expects companies’ forward guidance to be “overwhelmingly negative amid Brexit uncertainty.” The Brexit effect could dampen what US investors very much want to see, which is companies talking more positively about the second half of the year.
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