Look, here’s the thing: Goldman has got some shit on their chest they need to get off with regard to upcoming earnings results.
Normally, the bank’s “US Weekly Kickstart” notes are about “conversations they’re having with clients,” but this week’s iteration reads a bit more like “our projections for Q2 reporting season.”
What’s amusing about the bank’s Q2 earnings preview is that the themes are so self-evident/obvious to anyone who hasn’t been asleep for the entire quarter that there’s something disconcerting about the fact that this is what the bank is sending to institutional clients.
That is, read everything excerpted below and then try to imagine being an institutional investor and not already knowing all of it. If any of it surprises you, you probably shouldn’t even be allowed near your own money, let alone anyone else’s.
But, it’s Sunday and everyone likes a good earnings season preview, so fuck it. I’ll print it on the off chance anyone can extract some value from it.
The S&P 500 2Q earnings season begins in earnest next week. C, JPM, WFC, and PNC will report second quarter results on Friday, July 14. 89% of S&P 500 market cap will report earnings by August 4 (see Exhibit 1).
Consensus expects 2Q adjusted EPS will grow by 7% year/year, driven primarily by a 370% rebound in Energy EPS. S&P 500 EPS growth is expected to slow from 14% in 1Q, the fastest pace of growth since 2011. Excluding Energy, consensus forecasts earnings will grow by 4% in 2Q compared with 10% last quarter (see Exhibit 2). Info Tech (+10%) and Financials (+6%), the two largest contributors to S&P 500 earnings, are expected to deliver the fastest EPS growth this quarter outside of Energy.
S&P 500 sales are forecast to grow by 7% year/year in 2Q, while margins are expected to remain flat at 9.5%. Sales growth will likely be led by Energy (+26%) and Information Technology (+12%). Two sectors, Materials and Telecom Services, are forecast to experience declines in revenues. Only three sectors are expected to expand margins during the second quarter (Energy, Telecom Services, and Materials).
2Q earnings estimates have been revised lower by 3% YTD, in line with history. 10 of the 11 sectors have experienced negative 2Q EPS revisions in 2017, with only Real Estate EPS being revised higher (Exhibit 3). Although S&P 500 EPS estimates excluding Energy were revised down by 3% between January and May, they have been roughly unchanged since then, following stronger-than-expected 1Q earnings results.
We expect 2Q results will be modestly better than consensus currently forecasts. Economic activity is the most important driver of S&P 500 EPS and remained above trend in 2Q 2017. Our US Current Activity Indicator (CAI) averaged 3.1% in 2Q 2017, 60 bp faster than the 5-year average. Our economists estimate that US GDP also grew by 2.3% year/year in 2Q. US MAP, a measure of economic data surprises, remained in positive territory during the quarter. Although the 2Q earnings surprise will likely be smaller than in 1Q, reported earnings typically beat consensus forecasts, and the macro environment suggests this will also be the case this earnings season.
Fading USD strength and higher interest rates should also support 2Q EPS growth. The trade-weighted USD was just 2.6% stronger on average in 2Q 2017 vs. 2Q 2016, representing a limited headwind to internationally exposed companies. The 10-year US Treasury yield averaged 2.3% in 2Q 2017 vs. 1.8% in 2Q 2016. While some banks have noted that subdued trading activity during 2Q may weigh on earnings, a higher rate environment and increased buybacks and dividends following CCAR results will likely support Financials returns in 2H 2017. Every 100 bp increase in 10- year bond yields adds roughly $0.50 to annual S&P 500 EPS, all else equal.
The substantial decline in oil prices in June represents a downside risk to Energy EPS. Relative to 2Q 2016, average Brent oil prices were 8% higher in 2Q 2017, which will likely support a rebound in Energy EPS. However, oil prices rapidly declined from $56 in April to $45 in June. Energy EPS is therefore at risk from lower oil prices (lower revenues) and higher rig counts (higher costs). Consensus EPS estimates for Energy have already been revised down by 15% since the start of 2Q. Additional negative revisions to full-year Energy profits would pose a risk to overall S&P 500 EPS growth, given 25% of 2017 EPS growth is expected to come from Energy alone.
A tight labor market remains a potential headwind to Consumer Discretionary and S&P 500 earnings. The US economy added 222,000 jobs during the month of June and average hourly earnings grew 2.5% year/year. Many wage measures have shown signs of deceleration in recent months and our GS Wage Tracker stands at 2.4% (vs. 2.7% in 2Q 2016). However, given that the US economy is at full employment, our US Economics team expects wages will continue to rise. We previously estimated that a 100 bp acceleration in wage inflation would reduce annual S&P 500 EPS by roughly 1%. Labor-intensive sectors such as Consumer Discretionary are most at risk from rising wages. The combination of wage pressures and weakness in Autos and Retailing will weigh on Consumer Discretionary earnings, which are expected to fall by 3% in 2Q, the most of any sector.
Better-than-expected margins for large-cap Info Tech firms represent an upside risk to 2Q EPS. Consensus expects Info Tech margins will decline by 31 bp in 2Q. Mathematically, significant Info Tech net margin expansion appears unlikely following GOOGL and FB’s decisions in 1Q 2017 to change their accounting to include stock-based compensation in their adjusted earnings. The policy shift will act as a one-time headwind to the calculation of margins in 2017. However, Info Tech margins beat consensus forecasts in 1Q and we estimate full-year 2017 Info Tech margins will be stable at 19.9%.
Our top-down S&P 500 EPS growth forecast of 9% in 2017 and 7% in 2018 is below consensus bottom-up estimates for 11% and 12% growth, respectively. We expect Energy and S&P 500 margins will expand less than consensus forecasts. In our Second-half outlook last week, we identified 31 companies for which GS equity analysts expect margins to expand by 50 bp or more in both 2017 and 2018 (see Exhibit 5).