Like the first quarter reporting period, there is a lot of optimism in front of the second quarter reporting period that strong earnings growth will be just what this market needs to break out of the range-bound stupor it has been in since early February. Here's hoping for the bulls that things don't go the way of the first quarter reporting period.
Briefly, earnings for the S&P 500 increased 25.0% in the first quarter. That was the best earnings growth in more than seven years. The good news was relentless, yet so was the market's generally immutable response to all of the good news.
To wit, when JPMorgan Chase reported its better than expected results before the open on April 13, the S&P 500 stood at 2656.30. On May 31, the S&P 500 closed at 2705.27, up 1.8% from the time of JPMorgan's report.
There was nothing bad about a 1.8% gain, yet it belied the remarkable earnings growth for the first quarter and the remarkable earnings growth estimates for the rest of the year.
Worries about peak earnings growth and peak economic growth spoiled the reported earnings spoils in the first quarter, which leaves one to wonder: will this be a case of deja vu throughout the second quarter reporting period?
True to Form?
The second quarter earnings reporting period will have its official start on Friday when JPMorgan Chase (JPM), Citigroup (C), and Wells Fargo (WFC) report their quarterly results.
According to FactSet, the estimated second quarter earnings growth rate for the S&P 500 is 20.0%. That is up from an estimated growth rate of 18.9% on March 31, which is noteworthy because earnings estimates typically go down, not up, in front of a reporting period.
FactSet informs us, too, that the earnings growth rate from the end of the quarter through the end of the earnings season has typically increased by 3.2 percentage points on average over the past five years.
If the earnings reporting holds true to form, then, second quarter earnings growth could be pushing 23.0% when it is all said and done.
What everyone is anxious to see, however, is what level the S&P 500 is pushing when the second quarter reporting period is all said and done.
Strikingly, the S&P 500 is pushing 2800 as we write, which is the upper end of the trading range (~2600-2800) the S&P 500 has been locked in since early February and a level where resistance took hold in early March and again in June.
Presumably, a move through 2800 on a closing basis will set up the S&P 500 to retest the record-high of 2872.87 that was established on January 26.
A Battle of Wills
There is a lot of pent-up hope riding on the second quarter earnings reporting period. That hope is rooted in the understanding that earnings drive stock prices over the long term and that earnings growth estimates for the third quarter (+21.7%) and fourth quarter (+17.9%) are looking strong right now as well.
That hope is also rooted in the sense that the market is due to react better to encouraging earnings news than it did during the first quarter earnings reporting period, partly because a good bit of money has been flowing out of mutual funds in recent weeks and there could be a catch-up response in terms of positioning should there be a breakout.
Might that be wishful thinking? Perhaps.
It is certainly no mystery that the second quarter reporting period will produce another terrific quarter of earnings growth, and yet the S&P 500 was close to flat for the year less than a month ago.
Over the past six sessions, though, it has risen 3.1%, with some pundits attributing that turbo-charged move to burgeoning optimism that the second quarter earnings reporting period will leave investors more focused on the earnings-growth story and less focused on the trade conflict.
In some respects, it will be a battle of wills between what the market knows and what it fears.
That could create some trading friction for a forward-looking market. It knows that earnings growth will be strong in 2018, yet it also fears that protectionist trade measures, higher policy rates, a stronger dollar, and rising labor and commodity costs could conspire to knock down growth estimates.
The latter understanding is why the guidance coming out of the second quarter reporting period will be key.
Will companies highlight those factors, and especially the uncertainty about trade policy, as a basis for tempered earnings expectations, or will they sound an upbeat note in spite of them?
Financials in Focus
The growth picture for the second quarter isn't a lopsided one. All 11 sectors are expected to report year/year growth, which is true for both earnings per share and revenue.
Revenue growth is anticipated to be 8.7%, which is strong in its own right and an important driver of the bottom-line growth. The solid revenue growth also speaks to solid end demand, which is expected to manifest itself soon in a second quarter GDP report that many economists think will have a four-handle on it.
Once again, the energy sector, underpinned by higher oil prices, will be a dictating force for overall earnings and revenue growth in the second quarter. Analysts, according to FactSet, are forecasting sector earnings to be up 142.5% and revenue to be up 21.8%.
The information technology sector fits in there again, too, as a growth driver, with earnings estimated to increase 24.6% and revenue expected to be up 13.4%.
There will be questions as to how much of the good news has already been priced into the information technology sector, which is up 9.8% over the last three months and up 15.2% year-to-date.
That hefty outperformance versus the S&P 500, which is up 4.9% over the last three months and up 4.5% year-to-date, is a signpost that suggests stocks in this particular sector could be vulnerable to a sell-the-good news reaction.
Such a reaction wouldn't take the market by surprise so much as a reaction to selling good earnings news out of the financial sector would.
The financial sector is down 3.0% over the last three months and down 3.2% year-to-date. That's a particularly disparate performance for a sector that is forecast to deliver 27.2% earnings growth and 3.6% revenue growth for 2018, not to mention a sector that plays a major part in driving economic growth.
What It All Means
There is no question that second quarter earnings are going to be strong. There are lots of questions as to whether the stock market will react to the face value of those earnings or whether it will get caught up once again in the peak growth narrative.
With the S&P 500 on the doorstep of an important psychological level (2800), there is going to be a very quick reality check as the financial sector takes the reporting lead.
Trade issues, meanwhile, will continue to run in the background (and some days in the foreground) and those issues could break either way.
The newswires, though, are going to be dominated by earnings news that is mostly better than expected. Ideally, that good earnings news generates a market response that is better than the mostly immutable one that accompanied the first quarter reporting period.