How Bearish Corporate Earnings Are Broadening the Bull Market Rally

Despite a third straight quarter of falling S&P 500 earnings, an unusually large number of companies in the index are beating analysts’ estimates for Q3. This trend is significantly broadening the advance of the the 10-year-old bull market. Tech stocks have led the recent rally, but significant gains also have been posted by industrial, financial and health care shares, according to S&P Dow Jones Indices in a detailed report by The Wall Street Journal, summarized below.

So far in the Q3 reporting season, shares of companies that beat estimates have risen by an average of 2% in the two days after reporting results, double the five-year average of 1%, according to data from FactSet Research Systems. “We’re seeing little rallies in some of the growth segments and other parts of the market,” observed James Ragan, director of wealth management research at investment banking firm D.A. Davidson. “Expectations were low for some of the sectors exposed to the overall economy and trade. Some of those fears have really subsided, creating a good quarter,” he added.

Key Takeaways

  • The S&P 500 has rallied despite earnings being down vs. a year ago.
  • A large number of companies are beating low profit estimates.
  • Q3 2019 is on track to record the biggest profit decline since Q2 2016.
  • It also is on track to be the third straight quarter of falling profits.
  • The last time that happened was Q4 2015 through Q2 2016.
  • More profit declines are projected for Q4 2019, with rebounds in 2020.

Significance For Investors

“Investors are feeling pretty good and better than they did just a few months ago,” Mark Stoeckle, CEO and senior portfolio manager at Adams Funds, told the Journal. “Trade isn’t likely to get worse in the near term, the Fed just lowered rates and, on balance, earnings are pretty good. The market is almost calling a bottom on some of this.”

“We’ve gone from earnings being too high and needing to come down to earnings probably being too low and needing to come up,” Mark Hackett, head of investment research at Nationwide Funds Group, which has $65 billion in assets under management (AUM), told Bloomberg. “The tone of management teams in their quarterly communications are much more positive.”

Morgan Stanley advises caution, however. “With stocks now selling at 18.5 times earnings and the equity risk premium falling to 370 basis points, we think any upward moves must be anchored to improving fundamentals,” according to a note issued today by their Wealth Management Global Investment Committee.

Through Nov. 1, Q3 earnings have been reported by 358 companies in the S&P 500, or more than 71%. Analysts’ estimates were beaten by 76% of them, and 66% of those 358 companies have seen their stock prices rise, both of which represent 5-year highs. Moreover, companies that did worse than the estimates have been treated relatively kindly by investors. Their shares have fallen by an average of 2.1% in the two days after announcing earnings, less than the 2.6% average decline registered by stocks with negative earnings surprises during the past 5 years, FactSet adds.

The S&P 500 companies are also registering 5-year highs along other dimensions, per the Earnings Season Update issued by FactSet: 61% have reported sales that beat the estimates, and aggregate sales reported so far are 0.9% above estimates. However, while aggregate earnings reported so far are 3.8% better than the estimates, this is below the 5-year average.

To be sure, companies are beating extremely pessimistic expectations. While information technology stocks have been leading the recent rally, for example, that sector has been recording some of the worst YOY earnings declines. However, expectations were so low that it also is among the top sectors in terms of earnings beats, FactSet observes. The consensus among analysts also is that earnings will be down in Q4, followed by a rebound by 5% to 7% in Q1 and Q2 2020, FactSet indicates. The chances of a Q1 rebound may become less likely if the U.S. and global economy significantly weaken.