May 29, 2019

Based on preliminary data (through May 10), S&P 500 earnings per share (EPS) for the March quarter are expected to grow 1.3% and revenues should be up about 5.6% from the year-ago period (see Figure 1). While that represents a significant deceleration from the 2018 growth rates, it is better than most Wall Street prognosticators were anticipating ahead of the 1Q earnings season.

Back in early April, investors were fearful that lingering macroeconomic concerns and a flattening yield curve were signaling an economic slowdown and a looming earnings recession (i.e. two consecutive quarters of declining earnings). While that’s still possible, it is looking less likely now. Of course, there’s still some risk that the global economy (and corporate earnings) will be hurt by another round of tariff increases. However, the U.S. economy has proven to be quite resilient in the face of such challenges.

The sharp deceleration in the EPS growth rate is not too surprising considering the fact that we are coming off an unusually strong year for earnings in 2018. Fueled in large part by a reduction in the U.S. corporate tax rate from 34% to 21%, earnings for the S&P 500 rose 23% last year. As a consequence, companies are facing tough year-over-year comparisons.

While the domestic economy has remained very healthy, it’s no secret that international markets including Europe and China have been struggling (though recent Chinese government stimulus efforts appear to have helped). That has been a headwind for the multinationals. In addition, companies with significant overseas exposure are seeing last year’s currency tailwind turn into a modest headwind (about a 2% top-line drag, on average, from the stronger U.S. dollar).

As shown in Figure 2, corporate profit margins have also come down from last year’s elevated levels as companies have had to cope with higher raw materials costs as well as a tight labor market and rising transportation costs. The good news for corporate America is that the pace of increase for many of these input costs appears to be moderating.

With 448 (90%) of S&P 500 constituents having reported so far, 76% of companies have beaten the consensus (average of Wall Street analysts) on EPS and 57% have topped estimates on revenues. The EPS beat rate is well above the five-year average of 71% (per FactSet) while the revenue beat rate is about in line.

Health Care, Financials and Consumer Discretionary companies have posted the highest 1Q earnings growth rates (+10%, +8% and +7%, respectively) while Energy (-26%) and Materials (-14%) have lagged the most.

In terms of EPS beat rates, Information Technology (with 87% of companies beating the consensus), Health Care (85%) and Consumer Discretionary (81%) have had had the best results while Utilities (54%) and Energy (66%) have had the fewest positive surprises (see Figure 3).

Most of the Tech bellwethers posted better-than-expected earnings led by Microsoft (+20% yr/yr, a 14% beat) while the more cyclical Semiconductor group results were better than feared (though guidance was mostly disappointing). The huge earnings beat at (Net Income of $3.6 billion, or $7.09 per share, ~51% above the Street) set the pace for the Consumer Discretionary sector. Health Care earnings were solid, for the most part, but the stocks have been weighed down by politics. While the 2020 presidential elections are still a ways off, several of the candidates (most notably Bernie Sanders and Elizabeth Warren) have been talking about their proposed "Medicare for All" programs, which clearly spooked investors. Energy remains in a funk as upstream investments at the large diversified players have weighed on earnings while refining margins have been under pressure (though they should improve from here).

With the stock market in rally mode, investor sentiment was relatively high coming into the March-quarter earnings season. As a result, stock market reactions to positive earnings surprises have been more subdued than last quarter while misses have been treated more harshly. The average one-day reaction to an EPS beat was +1.2% (relative to the market) versus the long-term average of +1.6%. On the other hand, EPS misses have declined -3.5% (on a relative basis) versus the historical average of -2.4%.

Looking forward, Wall Street analysts expect earnings growth for the S&P 500 to remain in the low single digits in the June quarter (according to Refinitiv) and gradually improve to the high-single digits by the fourth quarter. For the full year 2019, consensus forecasts are calling for EPS growth of 3.1%, which is down from the 7.3% expected at the beginning of the year. Given the brisk pace of domestic economic growth and a few green shoots overseas, the current S&P 500 earnings forecast of $167 per share seems attainable and the 17.0x next twelve month P/E isn’t all that high considering the current low interest rate, slow and steady (a.k.a. "goldilocks") economy.


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