Earnings Season Shows Corporate America Just Refuses To Roll Over

Earnings season was supposed to show corporate profits declined in Q3, marking the first YoY drop since 2016.

With nearly 90% of companies having reported, that did indeed play out. S&P 500 earnings fell 1% YoY last quarter.

The good news is, consensus was looking for a 3% drop, meaning things turned out much better than expected, on balance (and leaving aside anyone’s predisposition to quibble with the quality of this or that report).

(Goldman)

As Goldman writes, margin contraction was also less pronounced than feared (-79bp versus expectations for a 108bp decline), while sales ex. financials and utilities grew 5%, essentially in keeping with expectations.

The other thing to note is that the aggregate figure arguably doesn’t capture the health of corporate profits in the US. This is something Goldman has been keen to emphasize for quite a while.

“Excluding Energy, S&P 500 EPS rose by 1% in 3Q”, the bank writes, in a note dated Friday evening, adding that “for mutual fund and hedge fund investors that focus on individual stocks, the earnings results of the median firm is more important than the overall index [and] the median stock reported EPS growth of 5%”.

That latter figure is basically the same as it was during the first two quarters of 2019.

So, in addition to optimism around trade, the recent push to record highs on the benchmarks has also been helped along by better-than-expected earnings. (And please, spare me the tedious efforts to explain why things are actually terrible – this is a generic earnings recap post, not an exercise in doomsaying and forensic accounting.)

Going forward, estimates for next year will almost surely come down, but that needn’t necessarily spell doom for stocks. Indeed, negative revisions are the norm.

“Consensus 2020 earnings estimates have come down by 4% since March 2019 and the current trajectory of revisions is consistent with the historical pattern”, the bank’s David Kostin goes on to say, on the way to reiterating that Goldman’s own topdown 2020 EPS growth estimate of 6% “implies further negative revisions”.

Again, it’s going to take more than that to damp sentiment, especially if Donald Trump can swallow his pride and finally ink some manner of interim trade agreement with the Chinese (and eschew the temptation to break the deal).

Speaking of that, Goldman calls the prospective Sino-US agreement a “two-sided risk”. “Year/year S&P 500 margins declined for the third consecutive quarter, as rising input costs such as wages and tariffs weighed on profitability”, the bank notes, striking a cautious tone, on the way to reminding everyone (and you probably don’t need to be reminded) that “from a cyclical perspective, wages and material costs continue to grow faster than prices charged [and] tariffs on roughly $370 billion of China goods remain in place”.

The removal of those tariffs (or even a portion of them) would certainly help mitigate margin pressure in 2020, especially at a time when wages are more likely to move higher than lower and both parties in D.C. will be keen on pressing for better pay (Trump in order to bolster his appeal with the middle class and the Democrats in keeping with the need to pacify the increasingly powerful progressive wing of the party).

As far as trends in cash spending, Goldman notes that buybacks were down 10% in the third quarter, while capex and R&D spend rose 8%.

(Goldman)

Those trends are either “good” or “bad”, depending on who you are.

If you’re the type who cares about the long-term viability of the companies you own, it’s nice to see capex and R&D hanging in there even if that means funneling less money to buybacks.

Of course, if all you care about is short-term gains and whether or not management succeeded in boosting the stock price this quarter and engineering a bottom line “beat”, well then it’s a cryin’ shame to see buyback spending drop.