Mid-July is quickly approaching, which means one thing for the stock market: the second quarter earnings reporting period is about to start. That should be a positive thought considering the reporting period is expected to bring to light another quarter of solid growth in earnings per share and revenue.
Don't let the downward revisions to second quarter EPS growth estimates fool you either. They have simply set the table for a host of positive earnings surprises to come in much the same way the downward revisions to first quarter EPS growth estimates did.
The only question today is, how much will the final EPS growth rate surpass the estimated EPS growth rate of 6.6%?
With earnings reporting history as our guide, it's a conservative bet that the final growth rate for the second quarter will be at least two percentage points above the estimated growth rate. Ironically, if that ends up being the case, it would mark a round-trip of sorts since the estimated EPS growth rate stood at 8.7% on March 31, according to FactSet.
If the second quarter reporting period follows form with the first quarter reporting period, however, 8.7% growth will prove to be conservative in its own right.
As a reminder, the estimated first quarter EPS growth rate stood at 9.0% on March 31. When the reporting period ended, the final growth rate was 14.0%, which marked the highest year-over-year growth rate since the third quarter of 2011.
That strong EPS growth helped fortify the stock market's returns in the first half of the year, yet it wasn't just a bottom-line story in the first quarter. Revenue growth of 7.6% was the strongest growth rate since the fourth quarter of 2011.
Said another way, the first quarter EPS growth wasn't just a function of cost-cutting, share repurchases, and lower tax rates. It was also top-line driven.
A similar story should play out for the second quarter as year-over-year revenue growth is projected to be 4.9%, according to FactSet.
The energy sector is expected to drive the revenue growth, which analysts expect to be widespread. In fact, there is only one sector -- telecom services -- that is projected to report a year-over-year decline in revenues.
Many companies have struggled to achieve pricing power, so its stands to reason that increased volume, which fits with increased end demand, will also be a driver of the overall revenue growth.
A Good Bit of Good
EPS growth is also expected to be broad-based in the second quarter, and just like revenue growth, it will be powered by the energy sector. The latter is projected to report year-over-year EPS growth of 392.2%, which is a function of having reported depressed earnings in the same period a year ago.
FactSet informs us that EPS growth for the remaining ten sectors would be 3.8% (instead of 6.6%) if the energy sector is excluded.
Regular readers know we don't adhere to such caveats when it comes to earnings reporting since it all matters for determining the market's valuation.
To this point, the business cycle is cyclical in nature so you shouldn't exclude negative reports when the earnings environment is bad any more than you should exclude positive reports when the earnings environment is good.
There should be a good bit of good in the second quarter reporting period even though nine out of eleven sectors have seen a cut to their EPS growth estimates since March 31.
There are only two sectors though -- the utilities and consumer discretionary sectors -- that are projected to report an outright decline in EPS on a year-over-year basis, and those declines are modest at 0.1% and 2.0%, respectively.
What It All Means
JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC) will get things rolling when they report their results before the open on Friday, July 14. After that, the floodgates will open on the reporting front.
Market participants will be paying close attention to the third quarter and full-year guidance provided during the second quarter earnings reporting period.
Reassuring guidance is necessary to support stretched valuations for many stocks, especially if long-term interest rates continue to press higher and corporate tax reform remains elusive.
The line right now, according to FactSet, is that third quarter EPS will increase 7.4% on revenue growth of 5.1%. For 2017, the projected growth rates are 9.8% and 5.4%, respectively.
Those estimated growth rates aren't static. They will change, and the extent to which they do, will influence the behavior of the stock market, which is looking for earnings growth trends to be a supportive element at a time when there is a heightened degree of uncertainty surrounding fiscal, monetary, and geopolitical policies.