​As Sam Sees It: Can Q3 Earnings Extend the S&P 500 Hot Streak?

Sam Stovall  |

Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.

EQ: Earnings season for the third quarter is now right around the corner. Looking at the first half of 2017, actual reported earnings have vastly outperformed against expectations, even beyond the historical average differential. Should we expect this trend to continue?

Stovall: I think that the trend will continue, but I’m not necessarily sure that the magnitude of it will. One reason for that is because we are now going to be comparing earnings growth against positive results from the third quarter of 2016. In other words, we’re not comparing positive 2017 numbers with negative 2016 results as we did during the second quarter. As a result, I do believe the trend will remain intact, however, the magnitude of the outperformance probably will not be the same.

EQ: What are analysts expecting for the S&P 500 for the Q3 earnings reporting season?

Stovall: Right now, believe it or not, they’re expecting earnings to be up only 4.0%. That’s the number that we’re looking at as of Oct. 4. Interestingly enough, only three days earlier on Sept. 29, S&P 500 earnings were estimated to be up 5.0%. So, in just three trading days, we’ve had the estimate come down by 100 basis points, primarily in the Financials space.

Last Friday, earnings were expected to be up 1.2% for Financials, but now the estimates are for a decline of 3.9%. That’s mainly coming from Wall Street analysts ratcheting down their estimates for insurance companies as a result of the fallout from Hurricanes Harvey and Irma.

EQ: Which groups are expected to be the leaders of this earnings season?

Stovall: Well, the clear leader is expected to be Energy, estimated to be up 130% because it’s comparing with very low numbers seen a year earlier. The second-best performer is expected to be Information Technology, up 10.2%, and third is Industrials, up 5.2%. Those three areas are expected to do much better than the rest. Consumer Staples is the only other sector expected to post above market returns with an estimated 4.6% gain in third quarter earnings. Everybody else is expected to show a lower growth rate, or even an outright decline.

EQ: Materials looks to be the biggest laggard among all the sectors this quarter, and has seen a big swing in terms of Q3 estimates in just the past few months. What was the cause of that?

Stovall: I think the reason is that you have Dow and Dupont merging into DowDupont (DWDP), and it seems to be more an issue of the timing of the earnings releases. Quite frankly, our Basic Materials analysts are scratching their heads thinking, why are these Wall Street analysts looking for a sharp decline in Materials? In general, they’re looking for earnings to do relatively well on an equally weighted basis.

But we’re also finding that, because of higher titanium prices, the paint companies are expected to be challenged in terms of earnings. Also, some of the gold miners are not expected to do all that well. So, I think it’s just a few companies here and there that are dragging down the rest of the group.

EQ: Considering the historical outperformance of the S&P 500 earnings estimates versus reported numbers, are there any particular groups that are best poised to really surprise analysts to drive this quarter’s outperformance?

Stovall: I think the surprise could be, as I mentioned, in Financials because nobody really knows where the growth is actually going to be. So, maybe we end up going back to being in the black for Financials rather than the near-4% decline that is currently being anticipated. Materials could end up surprising as well.

Basically, whenever you have an extreme, one way or the other, you’re more susceptible to surprises. If you have an extreme level of euphoria, then possibly there’s room for disappointment. If you have an extreme level of pessimism, then there is room to be pleasantly surprised. Energy is the area that has the biggest earnings growth expectations, so maybe we get a number that is not as good, but it will be serving as a tailwind for the S&P 500 earnings.

But Materials, Financials, and even to a lesser extent, Consumer Discretionary, which is expected to be down 2.2%, might end up surprising people to the upside.

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