“Q1 Earnings Were Great, But…” – Goldman Pours Cold Water On The Strongest Quarter Since 2011
With 91% of companies in the S&P500 having reported earnings for the first quarter, Q1 2017 earnings season is almost fully in the history books, and is shaping up as the best quarter for annual earnings growth in six years. According to FactSet, the blended earnings growth rate for the S&P 500 in the first quarter is 13.6%, up from 13.5% last week, while revenue is poised to grow 7.8% Y/Y. The rise in profits was a function of both solid sales growth (+7.8%) and a 41 bp expansion in margins to 9.4%.
Additionally, 75% of S&P 500 companies have beat the mean EPS estimate and 64% of S&P 500 companies have beat the mean sales estimate.
If 13.6% is the final growth rate for the quarter, it will mark the highest (year-over-year) earnings growth for the index since Q3 2011 (16.7%).
The first quarter will also mark the first time the index has seen year-over-year growth in earnings for three consecutive quarters since Q3 2014 through Q1 2015. Ten sectors are reporting or have reported year-over-year growth in earnings, led by the Energy, Financials, Materials, and Information Technology sectors. The only sector that has reported a year-over-year decline in earnings is the Telecom Services sector.
On the top-line, the blended sales growth rate for Q1 2017 is 7.8%. Ten sectors are reporting or have reported year-over-year growth in revenues, led by the Energy sector. The only sector that has reported a year-over-year decline in revenues is the Telecom Services sector.
The biggest driver to Q1 Y/Y earnings was the energy sector, which was crushed last year as a result of the collapse in energy prices. In fact, as Factset points out, a growth rate was not calculated for the Energy sector for Q1 because the sector reported a loss in the year-ago quarter. On a dollar-level basis, the Energy sector reported earnings of $8.5 billion in Q1 2017, compared to a loss of -1.5 billion in Q1 2016. Due to this $10.0 billion year-over-year increase in earnings, the Energy sector was the largest contributor to earnings growth for the S&P 500 as a whole. If this sector is excluded, the blended earnings growth rate for the remaining ten sectors would fall to 9.4% from 13.6%; even that number would still rank as the highest in nearly six years.
Away from energy, the Financials sector reported the highest (year-over-year) earnings growth rate of all eleven sectors at 19.9%. At the industry level, four of the five industries in this sector reported earnings growth. All four of these industries reported double-digit earnings growth: Capital Markets (37%), Diversified Financial Services (28%), Banks (19%), and Insurance (19%). At the company level, Bank of America was the largest contributor to earnings growth for this sector. The company reported actual EPS of $0.41 for Q1 2017, compared to year-ago EPS of $0.21
It wasn’t just the US that reported strong first quarter numbers, and according to calculations by Goldman earnings results are surpassing expectations around the world. An above-average share of companies beat earnings in STOXX 600, TOPIX, and MXAPJ, with the rebound in energy earnings the core catalyst for strong global earnings growth.
Results look particularly strong in Europe, where 54% of reporting companies beat on the bottom line, the highest share since at least 2008, thanks to strong results from Banks, Oil & Gas, and Health Care companies. Solid STOXX 600 earnings results coupled with lower valuations supports our view that European equities will continue to outperform US stocks in 2017 (see US Weekly Kickstart, April 21, 2017).
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Yet while on the surface Q1 earnings not only smashed expectations, but were the strongest in 6 years, it wasn’t all great news, and it was up to Goldman to spoil the party. In his overnight note, Goldman’s David Kostin writes that higher-than-expected 1Q earnings for S&P 500 have not translated into positive EPS revisions for the remainder of 2017.
In fact, since reporting season began, EPS estimates for the final three quarters of the year have declined by 0.5%. Current bottom-up estimates imply full-year S&P 500 EPS of $132, 7% above Goldman’s top-down adjusted EPS estimate of $123. The key forecast difference is net margins, which consensus expects will expand to all-time highs by 4Q while Goldman forecasts renewed slight margin compression (ex-Energy). Goldman specifically highlights accelerating wage costs as a clear risk to consensus margin forecasts. Goldman further observes that according to earnings call transcripts, firms from most sectors discussed rising labor costs on their 1Q earnings calls.
Furthermore, 4Q EPS estimates, which typically experience the largest negative revisions, have actually increased by nearly 1% since the start of 2017. 2018 estimates have also seen positive revisions during the last month. Since 2003, there have been just three years with positive 4Q EPS revisions and the historical pattern shows an average reduction of 6% during the course of a year. 2Q and 3Q estimates have declined by 3% and 1%, respectively.
So what is the take home summary: while the rebound in energy clearly had a dramatic impact on S&P earnings, mostly thanks to the base effect as a result of the net loss for the energy sector in Q1 2016, now that oil prices have anniversaries their rebound from 2016, and are in fact lower than a year ago, the “one time” boost from energy is over, and the easy “gains” have been made. Furthermore, if Goldman is right and rising wages – the Fed’s holy grail – do appear, it will be only downhill from here from corporate profit margins, and therefore the bottom line
Finally, there is the risk of Trump’s tax reform not taking place at all in 2017. Even Goldman no longer expects any favorable impact on 2017 earnings from lower taxes. “The prospect for tax reform is uncertain, but the calendar suggests a low probability of any impact on 2017 EPS.”
In other words, enjoy the Q1 earnings surge: it may not repeat. Additionally, “hstory strongly suggests that at some point this year investors will
have to digest negative revisions to 4Q EPS estimates. If share prices
do not fall alongside declining EPS forecasts, then portfolio managers
will implicitly be accepting a rising P/E multiple, which is already
stretched to near historical highs. Further valuation expansion seems
unlikely, especially given our forecast of accelerating inflation and
rising interest rates.”
Goldman’s bottom line: “we forecast the S&P 500 index will decline by
4% to 2300 by year-end 2017 as consensus EPS estimates are trimmed closer to our forecast.“