First quarter earnings season: Not as bad as it looks

11 April 2019

Earnings season is always an interesting time for investors, but first quarter publications are likely to be of greater importance than usual this year, given the current macro-economic context. Indeed, with the yield curve having inverted two weeks ago, investors are clearly on the lookout for any clues that a recession is on the horizon.

On the face of it, the bears will enter this earnings season with the upper hand. Consensus expectations point to a 2% year on year decline in earnings per share for the S&P 500 index. Should these predictions materialise, it would mark the first contraction in profits since the second quarter of 2016.

S and P 500 pre-announcement

Furthermore, pre-announcements have been negatively skewed, with a total of 85 companies revising their guidance lower, ahead of their actual publications. This compares to just 31 positive pre-announcements, pushing the negative-to-positive ratio to its highest level in the past three years.

Positive Surprises

Although this suggests a poor earnings season, we believe the next few weeks may actually offer some support to equity markets.

Low expectations should allow for positive surprises. On average, companies in the S&P 500 index manage to surprise analyst projections by 4% on average. Should this be the case again this time around, earnings growth may actually be positive this quarter.

In addition, full year 2019 earnings growth expectations have been slashed to just +3% year on year from +7.3% back in January. We believe this is relatively conservative, especially when top line growth is still expected to increase by 5%. It’s very uncommon for margins to contract when revenues are growing that much. As such, we see limited risk of any negative revision of 2019 estimates.

Short-term challenges

When looking at the sector breakdown, it also appears that a lot of the challenges expected for the first quarter may be temporary. The Energy and Materials sectors, for example, is expected to see earnings decline by 20% and 15%, respectively but we believe this figure fails to account for the sharp rebound in commodity prices witnessed since the beginning of the year.

Similarly, earnings in the all important technology sector are expected to contract by 6% this quarter led by semiconductors (-25%) and hardware (-16%). Yet, this appears very company-specific, with Nvidia (-60%) and Micron (-70%) on one side and Apple (-13%) on the other side responsible for the bulk of the contraction. This reinforces the view that the current environment benefits active managers, as highlighted in our latest Market Perspectives.

In conclusion, the first quarter of 2019 earnings season is unlikely to deliver an optimistic message. But, because expectations are so low, this does not necessarily mean stock prices will suffer. Instead, we believe that this quarter could mark the low point for negative earnings revisions, which would provide support to equity markets going forward.

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