There is zero doubt in the stock market's mind that the fourth quarter earnings reporting period is going to be a good one. The question is, will it be good enough?
The high expectations for the reporting period have manifested themselves in rising stock prices. The question is, will stocks fall victim to a sell-the-news response?
Everyone is waiting on the answers -- and the answers will be unrelenting over the course of the next month or so when S&P 500 companies share their results for the December quarter.
A handful of companies have done so already, yet the results shared by JPMorgan Chase (JPM), BlackRock (BLK), Wells Fargo (WFC), and PNC Financial Services (PNC) on Friday, January 12, will be acknowledged as the official start of the reporting period.
Below we look at prevailing expectations for the onslaught of earnings news that will serve as a trading catalyst for S&P 500 stocks, and many others, in the coming weeks.
Growth All Around
According to FactSet, S&P 500 earnings are expected to increase 10.5% year-over-year. That is down from an 11.3% growth rate projected on September 30.
The downward revision hasn't deterred the stock market, however. Since September 30, the S&P 500 has increased 9.7%.
Frankly, downward revisions don't carry much weight when pitted against the understanding that earnings growth is still expected to increase double digits for the third time in the last four quarters.
In the same light, market participants are also cognizant that analysts' current median estimates project double-digit earnings growth for the S&P 500 for every quarter in 2018.
There will be revisions along the way, but with the passage of tax reform, and the sharp cut to the effective corporate tax rate, earnings optimism is running high and has been a relentless source of support for the bull market along with the persistence of low interest rates.
When it comes to the fourth quarter, the projected growth is as broad-based as it can be. Every sector is expected to report a year-over-year increase in earnings. Importantly, the same can be said for expected revenue growth.
The energy sector (+132.7%) is at the head of the earnings estimate pack while telecom services (+1.1%) is bringing up the rear. The same goes for revenue growth estimates, which show the energy sector (+17.4%) leading the way and the telecom services sector (+1.8%) rounding things out.
Overall, S&P 500 revenues are anticipated to be up 6.7% year-over-year, which would be the strongest growth rate since the first quarter of 2017.
A High Bar
The latent risk with the fourth quarter earnings reporting period is that earnings expectations are too high.
FactSet informs us that the bottom-up EPS estimate has declined just 0.3% during the fourth quarter. That is far less than the average decline of 4.2% during a quarter over the last five years.
The dip in the earnings estimate during a quarter typically sets the stage for a litany of positive earnings surprises. Often, the final EPS growth rate tends to be two to three percentage points higher than the estimated growth rate just before the start of a reporting period.
That trend played out in the third quarter, which produced a final growth rate of 6.4% for the S&P 500 versus an estimated growth rate of 4.2% (which had been marked down from 7.5%).
What It All Means
It's fair to say that S&P 500 companies face a higher bar than usual for the fourth quarter earnings reporting period that could lead to more relative (and absolute) disappointments than market participants are accustomed to seeing.
With many stock prices having been bid sharply higher in recent weeks, stocks of companies failing to meet earnings estimates and/or offer satisfying guidance would be at risk of suffering material price declines.
Companies meeting estimates and reaffirming guidance are more likely than not to see some selling on the news of their otherwise in-line reports.
Like any reporting period, the guidance will count the most as a driver of stock prices since there is some question about stock prices having gotten ahead of themselves.
Fasten your seat belts.
The earnings reporting ride is about to begin and the reaction of the market will provide some telling answers.
(Note: The next installment of The Big Picture will be published Friday, January 26)