- We believe the earnings recession may have ended in the third quarter.
- We expect potential upside to third quarter estimates due to supportive economic data, stable oil prices, and U.S. dollar stability.
- We will be watching closely to gauge the confidence of management teams in their ability to produce solid earnings gains in the fourth quarter and first half of 2017.
We believe the earnings recession may have ended in the third quarter of 2016. As the drags from sharp energy declines and a strong U.S. dollar continue to abate, backed by a pickup in economic growth, the S&P 500 could potentially produce a small increase in earnings on a year-over-year basis in the just-completed third quarter. This week we preview the third quarter earnings season and discuss the always important outlook for management guidance.
EARNINGS GROWTH RETURNS?
Third quarter earnings season gets underway this week with Alcoa’s results after the bell on Tuesday, October 11, followed by nine other S&P 500 companies over the rest of the week. Thomson-tracked consensus estimates are calling for a 0.7% year-over-year decline in S&P 500 earnings (FactSet and Bloomberg consensus figures are 0.5-1.5% lower). Based on the typical quarterly upside of about 3% that companies have historically delivered, a 2-3% earnings gain is a reasonable expectation, even including an expected 3.4% drag from the energy sector. The average upside above estimates over the past five quarters is actually a bit better at 4.5%.
Should the S&P 500 produce an earnings gain, based on Thomson Reuters data, it would prevent the streak of earnings declines from reaching five (or six based on FactSet and Bloomberg data) and end one of the longest earnings recessions — though far from the deepest — in the history of the index. Revenue growth is expected to return in the third quarter as well, breaking a streak of six straight quarterly year-over-year earnings declines (third quarter consensus is +2.6%). Both metrics may have put in a trough [Figure 1].
THE GOOD NEWS
We expect at least the typical upside to third quarter estimates and, outside of energy, solid earnings gains for several reasons:
· Supportive economic data. The Institute for Supply Management’s (ISM) Purchasing Managers’ Index, one of our favorite earnings indicators, rebounded more than expected in September 2016 to 51.5. Gross domestic product (GDP) in the third quarter is tracking to near 3% annualized growth, a strong pickup from the sub-2% growth pace in the first half of the year. The U.K.’s planned separation from the European Union (EU) has had a limited impact on the global economy, or even Europe, as of yet.
· Stable oil prices. Although the energy sector will likely see another significant earnings decline (though smaller than in the second quarter), oil prices held steady during the third quarter and gained some momentum with an 8% increase in September. That may help energy companies, including energy infrastructure companies in the industrials sector, meet or exceed expectations.