There was much uncertainty entering this quarter’s earning season. The markets were only just starting to rebound after a disastrous December. There was a trade war, a government shutdown, and a slowing Europe weighing on investors. It felt like the perfect storm, and that the final straw would be a bad earnings season.
As Earnings began to filter in, they were not outstanding, but they were not terrible either. Investors took comfort, and the markets were buoyant. The trade news got better, and the government shutdown finally ended. It looked like investors had dodged the bullet, and there was more upside. But not so fast! Because while the Q4 quarter was okay, there were impending signs that future quarters were not going to live up to expectations, and that there needed to be some downwards adjustment.
Sailors say, “Red sky at night, sailors delight – red sky in the morning, sailors take warning”. Think of Q4 earnings as the red sky at night, and the outlook for Q1, and Q2 earnings as the red sky in the morning.
As we can now sum up the earnings season, it looks like over 70% of companies beat their estimates (source: Factset Earnings Insight). That sounds like a great number, but it is lower than usual, and indicates the pressure that companies are under right now. Technology companies led the way with 85% of companies beating estimates. Energy and Real Estate were at the tail end with only 52% and 44% of companies beating estimates. Both of these sectors are facing pricing pressure, and this has impacted earnings. See below:
The average Earnings Surprise for all companies was 3.3%. This means that on average, companies’ earnings were reported 3% higher than the final estimate from the Wall Street analysts. Putting that into context, 3% is on the higher end of the usual range of outperformance, so that was why that sigh of relief was heard!
Where are we headed:
As any good sailor knows, it is far more important to know the conditions ahead rather than the conditions behind. And we are heading into some rough seas, at least for another two quarters. Analysts are already bracing for a weak Q1 and Q2, and looking for a strong end to the year.
One indication of this turbulence is the number of corporations that issued negative guidance for the upcoming Q1. Corporate guidance is issued from the company itself, and is usually designed to warn analysts that their estimates may be a little high. For the quarter ahead, there have been over 70 companies in the S&P 500 issue negative guidance for Q1. These companies have been predominantly in the Technology and Health Care Sectors with 25 and 15 companies respectively.
If the first hint of a warning is corporate guidance, the full alarm is when analysts start dropping their estimates. This is already in full swing, and currently Q1 looks like a very weak quarter. The average drop in estimates in -3.2%. Technology(-10%), Materials (-11%) and Energy (-12) are the worst culprits.
So now it is the morning after the earnings season. While we escaped disaster last quarter, the seas are becoming roiled, the winds have begun to blow, and the clouds have darkened. The markets have reacted well so far, but now we will have to navigate the storms ahead.
(Author’s note: I know nothing about sailing).