Wall Street set for another stellar earnings season

Summary:

• US banks to launch earnings season on Friday, 12 October

• Earnings for the whole S&P 500 (US500) are expected to grow at the pace of 19.2% YoY

• Revenue growth forecasted to lag previous quarters

• Oil exploration and production companies viewed to outperform on the back of high oil prices

• Walmart (WMT.US) to report earnings on 15 November as the last Dow Jones (US30) component

As the third quarter of 2018 came to an end investors need to brace for the earnings season. As always major banks will kick off the Wall Street earnings marathon with the first report scheduled to be published on Friday (12 October). A bar of expectations is set high and we can be sure that the next two months will be abundant in some wild price swings.

In comparison with the previous decades the valuations of the S&P 500 stocks seem to be high. Each green or red line on the chart above refers to the percentile of all monthly P/E observations for the S&P 500 index times 12-month trailing EPS in a given month (i.e. “5%” line refers to fifth percentile of PE observations times 12-month trailing EPS in a given month). Source: Bloomberg, XTB Research

The most up-to-date estimates point that the earnings of the S&P 500 index as an aggregate grew at the pace of 19.2% YoY in the third quarter of the year. However, it should be noted that on average earnings tended to beat estimates by 3.5 percentage points over the previous 5 years. Having said that, if that average beat is repeated this time it will mark the third consecutive quarter when earnings of the S&P 500 index grew at pace higher than 20% YoY and third highest growth since Q3 2010 (lagging only behind Q1 and Q2 2018). Given that the new tax system in the US was not in place during the third quarter of 2017 the base for the upcoming earnings season is favourable and therefore a potential for a positive surprise is greater. When it comes to revenue the growth for the whole index is expected to reach 7.3% YoY. Such an outcome would fall short of the last quarter’s growth of 9.7% YoY.

Estimated third quarter earnings breakdown by sector (“Today” refers to 5 October). Source: FactSet

Before we move to individual sectors it is worth to mention that analysts lowered their earnings estimates during the quarter. At the end of the second quarter of 2018 (June 30) analysts expected earnings to grow at the pace 20.4% YoY during three months ended September 30. As we wrote in the previous paragraph the current estimate points to 19.2% YoY advance. Energy sector is expected to outperform other sectors when it comes to earnings growth. This is mostly due to higher oil prices (average price over 40% higher than in Q3 2017). Companies focused on oil exploration and production are set to see the highest earnings growth as an industry (3532% YoY advance) while refiners are poised to see smallest advance as an industry (8% YoY advance). Apart from that, financial and materials sectors are set to see all industries post double digit rates of earnings growth with insurers leading in the former sector (158% YoY advance) and miners in the latter (52% YoY advance). Consumer staples are viewed to see the least volatile earnings growth but it should be noted that companies from this sector saw the biggest relative upward revision of estimates against quarter end.

Estimated third quarter revenue breakdown by sector (“Today” refers to 5 October). Source: FactSet

Looking at the estimated revenue growth by sector one can see that when it comes to leaders and laggards the situation is the same as in the earnings growth breakdown. Energy sector is viewed to outperform other sectors with oil drilling and production industries leading the way. Once again refiners are seen to report the smallest YoY advance. On the chart above one can see that financials are among the worst sectors when it comes to revenue growth (unlike in the case of earnings). This suggests that strong earnings growth of this sector was mostly led by the higher interest rates translating into bigger margins rather than expansion of businesses. Apart from that, financials are viewed to be one of the biggest beneficiaries of the tax overhaul passed at the end of the previous year. For example, banks tend to have higher effective tax rates than other industries and because of that they were set to have the biggest upside potential once the tax rates were cut.

Just as US500 (S&P 500 futures underlying) managed to break to fresh all-time-highs the bull run was brutally halted by the same reason that doomed buyers back at the beginning of the year - spiking Treasury yields. The benchmark pulled back from the area around 2945 pts handle to the breakout zone in the vicinity of 2880 pts. Notice that the lower bound of the aforementioned zone coincides to some extent with the upward trendline (blue line on the chart above) and therefore bears may find it harder to breach. The course of earnings season may be crucial for the upcoming price movements of the index. Source: xStation5

Major US banks including JPMorgan (JPM.US) and Citigroup (C.US) will publish their earnings on Friday (12 October) as one of the first S&P 500 stocks. Most of the Dow Jones (US30) stocks will report their earnings during the first three weeks of the season. Walmart (WMT.US) on the 15 November will be the last Dow stock to do so and by that time close to 94% of the S&P 500 companies will have already published their reports.

Selected major US companies releasing financial statements during the first three weeks of the third quarter earnings season. Source: Bloomberg, XTB Research