Halfway Through Earnings: More Treats Than Tricks?

by Brad McMillan, CFA, CIO, Commonwealth Financial Network

As of the end of last week, more than half (55 percent) of companies in the S&P 500 had reported earnings for the third quarter. So, it makes sense to see where we are and what that means for the markets. On the whole, the news is good. But it has to be understood in the context of the recent hurricanes, which—to no one’s surprise—have hammered earnings in the insurance sector. (All of the data here comes from the FactSet Earnings Insight analysis.)

The top line

Let’s start with the top line. So far, revenues for the S&P 500 are up by an estimated 5.7 percent year-on-year. Ten of the 11 sectors have higher sales, and the current number is up from 5.1 percent last week on upside surprises from multiple sectors (e.g., energy and consumer discretionary). Two-thirds of companies have sales higher than the estimate, which is above both the one-year average (51 percent) and the five-year average (55 percent). From a momentum standpoint, revenue growth appears to be accelerating. The amount of the surprise is also accelerating, with overall revenues that are 1.5 percent above estimates, which is again above the one-year (0.6 percent) and five-year (0.5 percent) levels. Big picture? This is very positive.

The earnings level

We see the same trends at the earnings level. So far, earnings for the S&P 500 are up by an estimated 4.7 percent, with 6 of the 11 sectors reporting higher earnings. The earnings growth rate is up from 1.7 percent last week, again based on surprises in multiple sectors, led by information technology. More than three-quarters (76 percent) of companies are beating earnings estimates, again above the one-year (71 percent) and the five-year (69 percent) averages. The average amount of the beats, 4.7 percent, is below the one-year (5.1 percent) but above the five-year (4.2 percent) average.

These are positive numbers, suggesting continued growth. But they do hold some concerns. First and foremost is the drop in earnings growth compared with the past quarter. The reason here, however, is not weakness in corporate performance but simply the effects of the hurricanes on the insurance industry. So far, the damage is taking $6.9 billion off of profits, with an estimated $5.3 billion of that coming from four companies. This is a big hit to profits for the index as a whole—even though it really has nothing to do with the economy or real corporate performance.

Without this direct damage, the S&P 500 earnings growth rate would jump to something like 7.4 percent, a much smaller decline—most of which is likely attributable to the indirect damage from the hurricanes. While it is possible this marks a slowdown, the strength of the results at both the revenue and earnings level, relative to expectations, suggests that this is indeed just a one-off.

Market expectations are also consistent with this idea. Earnings growth is estimated to be between 10 percent and 11 percent for the next three quarters, while revenue growth runs just over 6 percent. These results are not too dissimilar to the results expected for this quarter, after accounting for the storms.

Trick or treat?

Overall, the news so far is that the fundamentals for the market remain sound. As I have noted in other places, the economy also remains sound, which makes it very reasonable that these expectations will play out. Of course, you never know what you’ll get come earnings season. But as of this Halloween, there are considerably more treats than tricks in the bag.

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Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation's largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth's investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by Brad McMillan.

Forward-looking statements are based on our reasonable expectations and are not guaranteed. Diversification does not assure a profit or protect against loss in declining markets. There is no guarantee that any objective or goal will be achieved. All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance is not indicative of future results.

Commonwealth Financial Network is the nation's largest privately held independent broker/dealer-RIA. This post originally appeared on Commonwealth Independent Advisor, the firm's corporate blog.

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