The third quarter has come to an end, which means the third quarter earnings reporting period is not far away. It will pick up in earnest in mid-October, yet the argumentative fact of the matter is that the third quarter reporting period is over before it even began.
The defensible case in point is rooted in the performance of the stock market and the direction of earnings growth estimates since the end of the second quarter. One went up and the other went down.
We probably don't have to tell you which is which, but for clarity's sake, the stock market has gone up and earnings growth estimates have come down.
Specifically, the S&P 500 has increased 3.9% since June 30 while the consensus earnings growth estimate has decreased from 7.5% to 4.2%, according to FactSet.
The reduction in the estimated earnings growth rate in front of a reporting period is standard operating procedure.
Analysts curtail their expectations based partly on company guidance and partly on a reassessment of their own estimates as they have better source data (eg. economic, industry contacts, competitor insight) as the quarter progresses.
The interesting thing about the third quarter reporting outlook is that fewer S&P 500 companies than usual have issued negative guidance. Per FactSet, 118 companies have provided guidance with 76, or 64%, issuing negative guidance. That's below the five-year average of 75%.
The caveat is that most of the guidance was provided prior to the hurricanes, so it's possible that more negative revisions are heard in the next few weeks as companies in the affected hurricane areas have a better accounting of the business disruptions created by the hurricanes.
Will it matter? Not for this stock market, which readily -- and rightfully in most instances -- excuses the warnings as a temporary setback.
That forgiving disposition has a lot to do, too, with the recognition that the fourth quarter earnings growth rate estimate of 11.2% has an ethereal, double-digit glow about it... as do the growth rate estimates for the first quarter of 2018 (10.4%) and the second quarter of 2018 (10.3%).
Of course, we expect to inform you in earnings previews for those respective periods that the growth rate estimates have been reduced, yet that will be an observation for a different day.
For now, that strong earnings growth outlook, which doesn't incorporate any impact of a tax reform package being passed, is making it easy for the market to look past the tepid earnings growth outlook for the third quarter.
It Is What It Is
The third quarter earnings view is what it is despite the energy sector expected to deliver year-over-year earnings growth in excess of 100%. If the energy sector is excluded, FactSet informs us that the S&P 500 earnings growth rate would slip to 2.5%.
Regular readers know we don't embrace the exclusion game since the market's valuation is predicated on the earnings reported from all 11 sectors.
Accordingly, we take the good with the bad and vice versa.
Notwithstanding the low projected growth rate, there is actually more good than bad expected for the third quarter. Eight out of 11 sectors are expected to report year-over-year earnings growth.
The other seven sectors have projected earnings growth rates ranging from 0.8% (Materials) to 8.8% (Information Technology). The three exceptions to the growth order -- Telecom Services, Utilities, and Consumer Discretionary -- are anticipated to see earnings declines ranging from 1.4% to 2.7%.
The revenue growth rate estimates have a more positive hue with all but one sector -- Telecom Services -- projected to report revenue growth ranging from 0.4% (Financials) to 17.1% (Energy).
S&P 500 revenue growth is expected to be 5.0% in the third quarter, which is solid growth and another encouraging offset to the tepid earnings growth rate.
What It All Means
Market participants will be anxious to hear the earnings guidance coming out of the third quarter reporting period. Expectations are on the high side, as noted above, with a weaker dollar, rising commodity prices, a pickup in global growth, and the launch of iPhone X contributing to the outlook.
Don't expect to hear much about tax reform other than these two points: (1) it would be helpful if it happened and (2) it isn't being accounted for in company guidance because nothing has been agreed to by Congress.
The latter point aside, the tax reform process will continue to grip the market during the earnings reporting period as the potential for a deal fits well in a bull market narrative. In other words, hope in a deal will most likely spring eternal into year end if there aren't any concrete spoilers in the interim.
So, as we stop to consider the upcoming third quarter earnings reporting period, it is shaping up as a can't-lose reporting period.
Hurricane-related weakness will be dismissed; the potential for tax reform continues to hang in the air; and the robust fourth quarter earnings growth estimate is a focal point making it easier to look past the lowered third quarter growth estimates, which are probably too low anyway.
To that end, it may be standard operating procedure for earnings growth estimates to be lowered in front of a reporting period, yet it is also standard operating procedure for the final earnings growth rate to be at least two to three percentage points higher than projected.
If the latter holds true for the third quarter, then the reporting period will be better than expected and over where it basically began.