A handful of big banks led by JPMorgan this week kicked off one of the more eagerly anticipated earning seasons in recent memory, with investors desperate for evidence that a revenue turnround is gathering pace and the rotation back into technology is justified.
Hopes are high. Headline earnings per share for the S&P 500 as a whole is expected to expand 9 per cent year on year this quarter, the fastest growth since the third quarter of 2011. Assuming the usual number of results beat forecasts, the US blue-chip gauge will comfortably see a healthy double-digit earnings per share jump.
But the closely watched metric will be flattered by the energy industry’s woeful start to 2016, which will make this quarter seem golden in comparison.
Strip out that sector and EPS growth is expected to tick in at a respectable but more modest 5 per cent, which would actually be a slower pace of expansion than in the past two quarters, David Kostin of Goldman Sachs notes.
Moreover, EPS ratios have in the post-crisis era been flattered by multibillion-dollar stock buyback programmes and corporate austerity. Many analysts and investors are therefore hopeful of more solid “top-line” revenue growth, which could entrench optimism that the US economy is on a solid footing.
“Companies have been able to grow earnings-per-share through financial engineering and cost-cutting, but now we can see top-line growth coming back again,” says Kevin Russell, chief investment officer of UBS O’Connor.
There has lately been a stark divergence between the so-called soft economic data, such as buoyant consumer confidence surveys, and glummer hard information, such as unemployment and retail sales.
The current consensus is for revenues to grow 6.9 per cent year on year — and solid numbers would fortify the view that the hard data were simply lagging behind — and reinvigorate a faded stock market rally, with the S&P 500 largely treading water since the start of March.
The early signs are promising. Citi and JPMorgan both outdid estimates on Thursday, but there is a broader swath of smaller companies that have financial quarters that end in February rather than March, and 74 per cent of the early reporters beat EPS estimates; 58 per cent beat revenues forecasts; and 48 per cent beat on both measures, notes Savita Subramanian of Bank of America.
That is well above the usual results, and tends to augur well for bigger blue-chips, too. Moreover, analysts have made more positive than negative revisions to revenue forecasts in March, for the first time since 2014.
Investors in information technology will hope that results justify this year’s 10.3 per cent rally for the industry’s shares, more than double the S&P 500’s 4.4 per cent gain. The consensus forecast is for a buoyant 13 per cent growth in EPS, trailing only behind materials and financials.
However, the outlook is darker for smaller US companies, or small-caps, which have been at the epicentre of the post-election “Trump trade”. The Russell 2000 has flatlined this year and earnings are forecast to have fallen 2.2 per cent in the quarter, according to Citi.
The longer-term outlook for the S&P 500 is also a little dimmer. Earnings estimates have in recent years tended to be gradually trimmed as the year progresses, and while the full-year 2017 forecast revisions have thus far been less negative than in the past, Mr Kostin at Goldman Sachs warns that this may not continue.
“Given the late stage of the economic cycle, higher wages, inflation, and interest rates suggest that margin increases this year are unlikely,” he wrote in his outlook. “Lower margins will translate into further negative EPS revisions in 2017 unless the current pace of economic growth persists, supporting faster S&P 500 sales growth, or policy tailwinds materialise sooner than expected.”
Combined with lofty US equity valuations, this is why some asset managers are beginning to turn their eyes more towards Europe, with many predicting a hefty rotation into the region if the populist Marine Le Pen fails to win the French presidential election.
“The US market is pricing in the maintenance of margins that history shows are hard to maintain. In Europe the opposite is true,” says George Evans, chief investment officer for equities at OppenheimerFunds.
Moreover, some investors remain doubtful that the hard economic data will be lifted by signs of animal spirits among consumers and in corporate boardrooms, and predict that US economic growth will largely continue to bumble along at the same solid but uninspiring speed of 2-2.5 per cent.
“We’re in the camp of believing the hard data will improve, but we’re sceptical that it will hook up in the same way as the soft data. So there’s scope for disappointment,” says Michael Roberge, co-chief executive and chief investment officer at MFS. “We’ll see this narrative play out in the coming quarter, and the softer data will probably weaken.”
Nonetheless, this would extend a “goldilocks” period of not-too-slow, not-too-quick economic growth that would sustain rising corporate profits and revenues, but not compel the Federal Reserve to act more aggressively to quell any inflationary pressures.
“As long as the data stays positive we should stay in a sweet spot of prolonged, moderate growth,” says Matt Peron, head of global equities at Northern Trust Asset Management.
“There are reasons to be cautious. Valuations will matter at some point. But as long as growth remains steady and rates low, then equities will be supported. The market isn’t as irrational as people think.”