Q3 earnings season look ahead: let the good times roll

Third quarter (Q3) reporting season is expected to see growth of 3.2% in earnings for US firms, which would make a significant drop from the 13.6% and 11.1% reported in the first and second quarter respectively. In late June, earnings were forecast to grow by 6.2%, so the downward revision has been quite drastic, but not as severe as that seen in prior quarters.

Over the previous two quarters, S&P 500 rallied hard into earnings season, gaining 4% into first quarter (Q1) and around 5.2% into Q2. A similar performance has manifested itself in recent weeks, as the index gains 4.9% from its August lows. A pause, therefore, could be in the offing as investors focus their attention on upcoming earnings.

The recent improvement in US data, typified by the robust reading from the September ISM manufacturing index, which hit its highest level since 2004, with all sub-indices growing, underlines the expectations of good performance for US companies this reporting season.

The weaker US dollar will provide a tailwind for earnings as well. US companies selling overseas will have found the environment of the past year much more congenial, as predictions of a great dollar rally were not just wrong, but out by a country mile. As UK firms discovered after Brexit, a weak currency can be great for flattering earnings and boosting share prices, even if it does increase the cost of imported components and goods.

What that means for indices is that we will likely see further gains towards the end of the year, as companies beat expectations that have been steadily guided lower. This might be something of a theatrical performance, but in the last analysis indices will be driven higher by the outperformance of companies that beat expectations.