The S&P 500 EPS estimate for the first quarter decreased 7.2% in the first quarter to $37.33, nearly in a straight line. That disappointing trend didn't bother the stock market, however. The S&P 500 increased 13.1% in the first quarter, nearly in a straight line, and is currently up 15.3% for the year.
In past columns, we have analyzed why the stock market has managed to trade up, and through, the negative estimate revisions. We'll boil things down here in three bullet points:
- The Federal Reserve pivoted to a dovish mindset.
- Optimism surfaced over the U.S. and China hopefully working out a trade deal soon.
- Market participants wrote off the first half of the year with an eye toward a pickup in earnings growth in the back half of the year.
So, does one really need to care about the upcoming first quarter earnings reporting season, which begins officially on April 12 when JPMorgan Chase (JPM) reports its results? Not really, yet that doesn't mean it won't matter.
The first quarter earnings-reporting period will matter for several reasons:
- It will show just how silly the market can be in its interpretation of good earnings news.
- It will provide some insight on the impact -- or lack thereof -- on multiple factors, like the government shutdown, the strong dollar, the tariffs, and the slowdown in Europe.
- It will be replete in many instances with guidance for the second quarter and full year.
The earnings-reporting period is euphemistically referred to as the silly season. Why is that? Because trading responses oftentimes defy headline cues.
Companies that miss estimates can trade up -- sometimes by a lot -- and companies that beat estimates can trade down -- sometimes by a lot. Those responses are often a byproduct of how a stock traded leading up to the company's report and/or a response to guidance that typically overshadows the results that were just reported.
In turn, there are oftentimes some silly reactions to how a company's earnings stacked up relative to expectations as opposed to how the company did on a comparable basis to the year-ago period. To wit, there can be a great deal of excitement that a company beat the consensus EPS estimate by two cents even though that result might translate into a double-digit percentage decline in EPS versus the prior year.
Where the silliness is going to abound this reporting period, though, is in relief that the results came in "better than expected" -- and they will come in better than expected. They always do, usually by three or four percentage points.
FactSet informs us that first quarter earnings are expected to decline 4.2% year-over-year. Accordingly, when the reporting is complete, first quarter earnings growth will probably be closer to flat.
Can we get a yeehaw? Flat growth is, well, nothing too stellar, yet it will compute nicely nonetheless as it will be "better than expected" going into the reports.
Let's be clear on this, though. It won't truly be better than expected.
On October 31, first quarter earnings growth was projected to be 6.6%, and on December 31, it was projected to be 2.9%. If things settle around flat, then, let it be known that first quarter EPS growth was simply better than the last estimate, but not actually better than first expected.
Plenty of revisions to go around
There have been a lot of negative revisions. In fact, all 11 S&P 500 sectors have seen EPS growth estimates lowered since December 31, according to FactSet, and only four sectors -- utilities, health care, real state, and industrials -- are expected to report any yr/yr growth.
In a sign of the times, the information technology and energy sectors are expected to report some of the largest yr/yr declines in EPS of 10.6% and 20.1%, respectively, and yet those two sectors have been among the best-performing sectors in the S&P 500 year-to-date with gains of 22.3% and 17.9%, respectively.
Moves like that in the face of downward earnings revisions are why one can legitimately ask if the first quarter results will even matter. They will give pundits and the media a lot to talk about, but they won't give the market anything it doesn't already know.
The market knows the government shutdown was a problem; it knows the strong dollar is a headwind for U.S. multinationals; it knows the tariffs and the uncertainty of the trade negotiations have curtailed business investment; and it knows the slowdown in Europe, and other economies, has crimped sales prospects.
Those factors, and others, are wrapped up in the negative earnings estimate revisions that have been talked about for months now, and which we are talking about again today.
Market participants have already crossed this bridge, and they have shaken the dust off their feet on their way to a bridge that gets them to the back half of the year when earnings growth is anticipated to be stronger.
If nothing else, the first quarter reporting period will matter because it will produce guidance. That guidance should shed some light on whether the bridge to the back half of the year is a smooth one or paved with speed bumps that will slow the rapid-fire recovery pace at which the stock market has been traveling.
According to FactSet, second quarter EPS growth is currently expected to be unchanged yr/yr while calendar year 2019 EPS growth is expected to be 3.6%.
What It All Means
There is a lot of optimism embedded in stock prices -- or perhaps what we should say is that there is a lot of relief embedded in stock prices.
There has been tremendous relief in seeing the Fed isn't going to be raising interest rates; there has been relief in the idea that the U.S. and China seem to want to get a trade deal done; and there has been relief in the awareness that the U.S. economy is still holding up better than feared.
From an earnings standpoint, there is real hope that the trade deal gets done and paves the way for a reversal in the earnings estimate revision trend, as a trade deal that lifts tariffs is considered a pathway to improved confidence that translates into stronger levels of business and consumer spending.
The trend in the first quarter EPS estimate has been decidedly negative, but ironically, one can argue that there is a lot of hope wrapped up in those downward revisions.
The hope is predicated on the view that the first quarter is the worst of things and that EPS growth estimates soon go the way stock prices are suggesting they will, nearly in a straight line.