US Q2 reporting season preview – will great expectations be met?

Chief Investment Officer and founder of Aitken Investment Management
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The second quarter US earnings season gets underway this week, and expectations are for strong earnings growth. Wall St needs to see strong quarter-on-quarter earnings growth for the US equity rally to broaden out from its current dangerously narrow reliance on just a handful of tech giants.

It’s worth noting just how narrow the US equity rally has been this year before we get into the Q2 earnings season preview.

Concentrated effort

Amazon, Netflix and Microsoft together this year are responsible for 71% of S&P 500 returns and for 78% of Nasdaq 100 returns. The three stocks make up 35%, 21% and 15% of S&P 500 returns, respectively, while making up 41%, 21% and 15% of Nasdaq 100 returns. Apple also makes up a large portion of both indexes, contributing 12% of both S&P 500 and Nasdaq 100 returns, while Alphabet and Facebook contributed 8% to each. In total for 2018, the six stocks make up 98% of S&P 500 and 105% of Nasdaq 100 gains.

Yes, you read that correctly, just six stocks: Amazon, Netflix, Microsoft, Apple, Alphabet (Google) and Facebook contributed 98% of the S&P500 gains this year and 105% of the Nasdaq 100 gains this year. I consider that a dangerously narrow rally particularly given that the valuation of Netflix, for example, is now ridiculous.

While Netflix (NFLX.US) shares seem to go up every day, and are now up 116% in 2018, the valuation is absurd in my opinion. It may well get more absurd, but paying a P/E of 288x trailing earnings or 145x 2018 earnings and a market capitalisation of US$180 billion doesn’t seem a sensible thing to do. The $180 billion market capitalisation for Netflix is the same as the Coca-Cola Company, higher than Walt Disney, double Caterpillar and closing in on Home Depot at $227 billion. It’s absurd, and a classic example of a stock and sector “peaking on euphoria” that will never deliver the earnings to justify the monster P/E (see our Professional’s Pick today for a different view).

Just remember, US equities in 2018 have been a “six stock show”. That is not healthy and when you overlay the flattest US 2-10yr yield curve in a decade (which signals recession ahead) there is cause for concern in US equities. That is why this earnings season is vital for US equities. The broader market needs to confirm and beat earnings expectations.

It’s worth remembering, that the growth versus value relationship in equities is at its widest point since just before the bursting of the DOT.COM bubble in 1999. This chart is basically US tech versus everything else.

This is also important for the P/E premium US equities are commanding to the rest of the world (see chart below). If that is to hold, this US earnings and outlook season needs to deliver.


With the help of Morgan Stanley, I will run through expectations for the crucial US Q2 earnings season.

Second quarter 2018 EARNINGS PREVIEW

This earnings season, as was the case in 1Q18, is characterized by high quarterly earnings y/y growth, a lack of downward revisions ahead of reporting, and the importance of forward guidance (perhaps more than results). Last quarter earnings season delivered above-average beat trends but failed to provide a meaningful boost to the market. Stocks underperformed the market by 49bps on earnings day. The disconnect between earnings beats and earnings day relative performance observed last quarter is a sign that outright EPS beats likely will not be enough to move stocks higher. Further guidance higher or markedly positive management commentary would be necessary. Bad news is that downward risks seem bigger on both fronts – full year 2018 estimates may be revised down this earnings season, and geopolitical risks continue to create uncertainties for management teams. Important to listen for this earning season is commentary around trade tariffs and their potential impact on revenues and margins.

Quick Statistics:

  • S&P 500 Second quarter 2018 Quarterly EPS Growth = 20.1%
  • S&P 500 Second quarter 2018 Quarterly Revenue Growth = 6.9%
  • Best EPS and Revenue Growth = Energy (141% EPS, 21% Rev)
  • Worst EPS and Revenue Growth = Consumer Staples (-1% EPS, -9% Rev)
  • Biggest Reporting Week = The Week of July 23

Second quarter 2018 is expected to see 20.1% YoY EPS growth, lower than last quarter’s 25% growth but still elevated versus growth rates in recent history and likely at the high end of upcoming quarterly earnings growth rates.

Full year 2018 EPS growth is currently forecast to be 21.4% for the S&P 500 (2018e EPS $161.79). 2018 Y/Y EPS Growth has continued to revise higher the past few months and only recently (in the past week) saw one YoY downward revision off the high.

Second quarter 2018 EPS GROWTH BY SECTOR

Energy is projected to see 141% Y/Y EPS growth in second quarter 2018, the highest among all GICS sectors. S&P Energy sector’s $14 billion of quarterly earnings is the highest earnings dollar amount since 4Q14, and Energy earnings make up 4.6% of S&P 500 earnings, which is the highest portion since 3Q15. Tech follows with 28% YoY rate and Telcos, Materials, and Financials at 21%. Once again, Consumer sectors and Utilities are projecting the lowest Y/Y EPS growth: Staples -1%, Utilities 5%, and Discretionary at 7%. Consumer Staples are the one sector projecting an earnings decline in 1Q18.



Second quarter 2018 is projected to see 6.9% Y/Y revenue growth, which is lower than last quarter’s 7.1% growth but still on the elevated side versus recent few years. Energy and Health Care are expected to see the highest Y/Y revenue growth at 20.9% and 16.8% respectively. Meanwhile, various defensive sectors are once again expected to see the lowest revenue growth: Staples -9%, Telcos 0.6%, and Utilities 0.8%.

Second Quarter 2018 Earnings Calendar

This week 4.5% of the S&P 500 market cap reports, and notably, 26% of Financials will be releasing numbers, including Citi, JP Morgan, and Wells Fargo. By the end of the month of July, 76% of the S&P 500 will have reported earnings. The biggest week for second quarter 2018 earnings season is the week of July 23rd, when 40% of the S&P market cap is projected to report.

Names reporting this week include:

All in all, with a very narrow leadership group this year, US equities need to pass the quarter two earnings test this month. Let’s see what comes but I hope by reading this note you’re at least aware now that ONLY SIX STOCKS have driven this Wall Street rally in 2018. That is NOT a healthy situation and may well prove to be a relative market peak.

It’s time to be sensible and disciplined.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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