On Friday, we brought you some excerpts from the latest by Wells Fargo’s Chris Harvey who thinks maybe “old grizzled PMs” might be pissing in everyone’s Cheerio’s by talking about late-cycle dynamics and curve flattening and other shit that’s just generally a bummer.
Here’s Harvey, for anyone who missed it:
Conversations suggest there’s been some major back and forth between Analysts (generally younger & less seasoned) and PMs (usually older and grizzled). In 2018, seasoned PMs have been worried about a turn in sentiment as the curve flattens and fears of a cyclical peak crescendo. Initially, PMs appeared to be taking a ‘sell the news’ regardless of results and analyst opinions. Now, the analyst story of solid earnings / guidance, improving fundamentals and valuation seems to be gaining traction.
And look, there’s nothing wrong with that view. After all, Q1 gave us a little multiple contraction which effectively acted as a pressure valve for the squealing kettle that, as of mid-January, clearly needed to let off some steam and earnings have been great.
“Our positive equity view is based on two exceptionally strong fundamental drivers,” JPMorgan’s Marko Kolanovic wrote earlier this month, reminding you that earnings have been “record-setting” and emphasizing that we just witnessed what was “by some metrics the strongest 1Q season ever”.
Here’s a recap from Goldman, out on Friday evening (note the boost from tax cuts to the bottom-line):
Bottom line: S&P 500 EPS grew by 23% in 1Q, the fastest pace of growth since 2Q 2011 (see Exhibit 1). The aggregate result was 5 pp above initial EPS forecasts. Sales rose by 11% year/year, above the original consensus expectation of 10%. Pretax earnings rose by a stellar 13% led by Energy (+78%), Information Technology (+23%), and Materials (+18%). Tax reform contributed significantly to bottom-line EPS growth, as the median S&P 500 tax rate fell to 21% in 1Q 2018 from 28% during the comparable year-ago quarter. Net margins expanded by 107 bp to 10.7%.
Growth: Energy sector EPS growth of 92% benefitted from the soaring price of WTI crude (+21% vs. 1Q 2017). Outside of Energy, earnings growth was strongest in Information Technology (+31%), Financials (+26%), and Industrials (+25%). Info Tech firms delivered 22% sales growth and 152 bp of margin expansion to 22.0%, more than double that of the rest of the S&P 500 index (8.7%).
But as the above-mentioned Harvey alluded to on Friday, these beats have generally been met with skepticism or, if that’s assigning too much in the way of meaning to the market’s generalized failure to reward beats, then we can at least say that the market has “shrugged” (as it were).
Despite 55% of the S&P beating already high expectations by at least 1 standard deviation, Goldman notes that market participants haven’t been in a particularly celebratory mood:
Firms posting positive EPS surprises outperformed the S&P 500 by a median of 45 bp on the day after announcement, well below the historical median of 104 bp. Notably, companies including GOOGL (-343 bp vs. S&P 500), DIS (-277 bp), and C (-127 bp) all underperformed S&P 500 after beating consensus EPS estimates by more than one standard deviation. Firms missing on earnings were also punished more severely than usual. The typical stock missing consensus EPS expectations lagged the S&P 500 by 296 bp the day after earnings, faring far worse than the historical median of -211 bp.
What accounts for that? Is that a reflection of the “old, grizzled PM” crowd’s skepticism about late-cycle dynamics prevailing? Well, not exactly. Rather, Goldman says folks have simply started to look ahead to 2019 and are generally viewing Q1 as somewhat anomalous.
“Analysts do not expect the conditions that led to upside in 1Q EPS to persist for the remainder of this year,” Goldman goes on to write, adding that “since the start of reporting season, revisions to S&P 500 full-year bottom-up 2018 aggregate consensus estimates total $2.33, barely above the positive 1Q EPS surprise of $1.94.”
The bank goes on to say that PMs are starting to revert to the pre-crisis tendency to value stocks based on next year’s profit outlook after Q1. In that regard, Goldman writes the following:
Analysts currently forecast the S&P 500 will grow 2019 sales by 5% and EPS by 9%, with net margins anticipated to rise by 48 bp to 11.5%. From a topdown perspective, equities have historically generated revenue growth consistent with nominal GDP growth, which Goldman Sachs Economics forecasts will equal 4.3% (real GDP growth of 2.2% plus inflation of 2.1%). Non-US sales account for roughly 30% of total S&P 500 sales and will benefit from faster global GDP and inflation. Indeed, forecast sales growth for the median S&P 500 constituent equals 5%. Exhibit 3 contains the distribution of 2019E sales growth for S&P 500 firms.
So I mean clearly, a lot of this is contingent on i) the veracity of the “new” narrative about a burgeoning global slowdown, tipped by the Q1 softening of the data in the eurozone and the U.K., and ii) on any assumed margin pressure that might accrue to U.S. corporates from upward pressure on wages and compensation more generally.
It goes without saying that a recession throws all of this completely out the window. As a reminder, here’s Goldman’s recession probability monitor over different time frames:
I would argue that indeterminacy with regard to the prevailing list of top worries is also weighing on sentiment and thereby making investors gun shy when it comes to celebrating earnings.
The regulatory questions hanging over tech are an issue, the flattening curve is bad news for the banks and Trump’s insistence on keeping everyone in the dark on literally everything (he’s reportedly bragging to aides that “No one knows what I’m going to do”) have all conspired to cloud an otherwise sunny medium-term outlook.
When you throw in the psychological overhang on the BTFD crowd from the February experience and institutional investors’ apparent hesitancy when it comes to re-risking, you end up with what we got during Q1 earnings season: a demonstrable propensity from investors to give great results the Kanye shrug.