Current expectations suggest the US reporting season will see a decline of 3% in Q3 earnings compared to a year ago, versus a rise of 1.6% in revenues. In Q2, earnings fell by 2.7% and revenues were down 0.2%. The Q2 figure was an improvement over expectations, which had forecast a 5.9% fall in earnings and a drop of 0.7% in revenues. Q3 is likely to have benefited from higher commodity prices and a reduction in dollar strength, both of which plagued the Q1 and Q2 earnings seasons.
Overall growth in earnings has been negative, with Q2 the fifth consecutive period when earnings declined. Energy, of course, was a major influence on this, but overall the last year or so has not been one of the best periods for US earnings. However, now we may be entering a better period, as growth picks up in Q4 and heads higher in the first part of 2017.
Crucially, while profits continue to be weak, it may be the ‘profits recession’ in the US has bottomed, and further improvement should provide a strong tailwind for stocks. Analyst estimates are also still on the cautious side. Recent surveys by Thomson Reuters suggest an overall forecast for a 0.8% decline in earnings; usually analysts cut expectations into the quarter anyway. Since the average earnings surprise since Q2 2009 has been 4.8%, there is plenty of room for a bounce in earnings, helping to crystallise bullish sentiment. Q2 2016 saw an earnings surprise of 3.6%, so it might not take much for a standout earnings season to develop, especially since the fundamental picture has improved markedly over the past 12 months.
It is important to remember that earnings season usually leads to some hefty increases in volatility, especially in those stocks that noticeably beat or miss expectations. Buying a stock going to earnings can provide some interesting opportunities, but it will usually lead to wilder swings in the price, which means investors should be carefully prepared where position sizing and stops are concerned.
Overall the economic outlook for the US is encouraging, and given ongoing seasonality trends which suggest a strong performance for stocks overall in the final quarter of the year, a period of weakness could provide an interesting buying opportunity with respect to a year-end markup in equity prices.