US Reporting Season: what to expect from this quarter’s results

Markets are expecting another disappointing earnings season from US corporates.

When is US Reporting Season?

The US Reporting Season for Q4 kicked off in the middle of January, and will extend to around the middle of February.

The market data that matters (S&P500):

Forcast EPS Growth (YoY)

Forecast Revenue Growth (YoY)

Current Price-to-Earnings

Current Price-to-Sales

Current Dividend Yield

-2.0%

2.6%

22:1

2.42:1

1.80%

What is the market expecting out of this earnings season?

At -2.0%, another quarter of negative earnings growth would mark the fourth successive quarter in which corporate profits have contracted. This, despite an S&P500 that consistently racked-up fresh record highs throughout that period. Revenue growth is also expected to be particularly disappointing, projected to come-in across the S&P500 at a measly -2.6%. Always forward looking, markets are hoping that this reporting period will mark the end to the US earnings recession, and earnings downgrading cycle. Market participants are broadly expecting an improvement in profits in coming quarters, which will justify the US stock markets currently rich valuations.

What are the key themes to watch out of earnings season?

Q4 earnings: a symptom of 2019’s global economic slowdown?

A key theme in financial markets last year, of course, was the slowdown in the global economy. Driven just as much by cyclical factors, as geopolitical issues like the US-China trade-war, and to a lesser-extent, Brexit, US corporate results for the fourth quarter are expected to reflect this weakness in the global economy in 2019. The forecast contraction in US earnings growth last quarter is being underpinned primarily by a projected drop in earnings per share (EPS) for cyclical stocks. Data compiled by Bloomberg is suggesting earning in the energy sector ought to have contracted by 39% in Q4, while earnings in the materials sector is forecast to have fallen by 16.3%.

Is this finally the end of the profit downgrading cycle?

Earnings growth has been negative for three successive quarters, and another contraction in earnings in Q4 will mark the fourth. Market participants have this “priced-in”, and are likely to stomach another drop-in earnings growth so long it does not undershoot the -2% estimate. The core issue for the market will be signs that earnings ought to pick-up from hereon in. And significantly, that there is an absolute end to the “downgrading” cycle that’s unfolded for much of the last 12 months. As it’s currently forecast, this ought to be so, with analysts projecting EPS growth for the next quarter at an improved 3.1, and growing at a stronger rate than that in quarters beyond.

Will market fundamentals begin to justify price and valuations?

Conventional wisdom suggests that all that will be required to see the S&P 500 continue to run higher is a better than forecast outcome to this earnings season. Given US corporate’s propensity to under promise and over deliver, this looks highly likely. The market will probably be looking for a roughly 75% positive surprise ratio. The broader question at the end of the earning season will be whether the results delivered justifies what are, at present, very rich valuations. Price-to-earnings for the S&P500, just for one, at 22:1, is currently trading at 24% premium to its 10-year average, and is at a 10-year high.

How could this earnings season impact the financial markets?

S&P500

Going into US earnings season, Wall Street stocks were already running hot, clocking up record-high after record-high. Both fundamentals and technicals point to an over-loved market. Though the medium-term outlook is justifiably positive, in the short-term, valuations are currently very rich – by some measures, as rich as they’ve been since the Dot-Com bubble – and the technicals suggest a currently “overbought” market. Earnings growth across the S&P500 needs to, it would seem, at a minimum, exceed expectations, and deliver a high margin of upside surprises. In the absence of that, a disappointing US earnings season could be the catalyst to spark the short-term reversal many in the market are tipping.

Cross-market view

Bullishness is sweeping global markets: that’s manifesting almost as much in other asset classes as in the stock market. Traders are swept up in the so called “reflation trade”, whereby investors are betting that lower geopolitical risk, coupled with very accommodative global monetary policy, supports a rebound in global economic activity. If US earnings season roundly beats what was expected from it, then this narrative may take greater hold. That ought to see a drift away from safe-havens, support upside in other global equity indices, and drive buying activity in growth sensitive assets, like industrial commodities, and perhaps currencies more sensitive to growth, such as the AUD, and emerging market currencies.

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