In the latest weekly+ I touched briefly on earnings season in the US, where results are (and stop me if you’ve heard this before) better than feared.
Indeed, Goldman’s David Kostin called “better than feared” the “key investor takeaway” with results in from nearly half of S&P 500 firms.
The bar was lowered. Analysts cut estimates by 300bps over the course of Q2, Kostin noted. By the time reporting season rolled around, consensus expected a 9% YoY drop in aggregate profits. So far, the decline is nowhere near than deep.
America’s earnings recession is generally expected to end in Q3, or by Q4 at the latest. Some bears still contend there’s significant downside to consensus for profits in the back half of the year, in part due to lost pricing power as inflation fades. Frankly, that narrative is starting to feel a bit like the contention that equities are destined to revisit the October lows. Maybe “far-fetched” is too harsh. I’ll go with “unlikely” instead.
Certainly, investors are focused on the outlook more so than Q2’s results. The market isn’t rewarding beats. But overall, guidance is positive. At worst, it’s neutral. Q4 2022 was the “low” point, where that means management was the most negative.
“Estimates for the second half of 2023 overall have been cut -0.4% since the start of the earnings season, which have been more than offset by the big beats in Q2 to take full-year 2023 estimates higher by 1.1% to $223,” Deutsche Bank’s Binky Chadha and Parag Thatte remarked, adding that by this stage in reporting season, current-quarter estimates would typically be 1% lower. Instead, Q3 estimates have been cut by less than half that. Q2 margins are tracking for 12.4%, close to pre-pandemic highs, albeit obviously below 2021’s peak. Excluding energy, margins are 80bps higher from the Q4 trough.
Note also that if you strip out energy (where earnings were guaranteed to fall sharply YoY for obvious reasons), EPS growth might’ve been positive last quarter. That’s how things are tracking currently. You can see that in the left-hand figure below.
Deutsche Bank’s Chadha looks at “underlying earnings,” which exclude energy and “lumpy loan loss provisions by banks.” On that measure, S&P profits are at a new high. “Underlying earnings are on track to rise 4.4% in Q2 (QoQ SA), following a 4.5% rise in Q1, more than recouping the 6.4% decline from Q1 to Q4 2022,” he wrote.
Overall, 81% of companies have beat so far. The historical average is around 75%. Three quarters of companies beat in Q1. The 2022 low was 66%. As of Friday, 56% of companies had beat by at least one standard deviation. The size of earnings beats this quarter is above average.
If you’re aggrieved by this charade, you’re either new to markets or you’re being disingenuous. Keep that in mind when you read soundbites from top-down strategists feigning surprise at another “better than feared” reporting season. It’s all just entertainment — sportscasters editorializing around a game their colleagues helped fix. And making $400,000 a year (or much more in some cases) to do it. Don’t misconstrue the point. There’s nothing illegal about any of this. But there’s a lot about it that’s asinine.
You’re taught in business school (and much earlier than that) that profits and sales are objective phenomena. But like money itself, they’re really just concepts. And they’re quite malleable. There’s “adjusted earnings” and “managed revenue” and on and on.
Wall Street’s forecasts for those concepts are based in no small part on company guidance. And all parties have an incentive to ensure that whatever the top-line shows, the bottom-line is healthier than expected (or “better than feared”).
It’s in everyone’s interests for companies to “beat.” So beat they will.
None of this is real. Sorry.
Those last three paragraphs seem so simple and are at the core of logic… sometimes leaving us stuck in the Mud..
My largest and longest running client was a nice bank run by decent guys. I helped with strategic planning two or three meetings a year for 20 years. My main job was to protect them from stupid and finish by writing a report that would satisfy the regulators, the same as everyone else hired guys much more expensive than me to do. I could never quite get over the “results management” discussions. Banks have a couple of tools for this, as do most firms. Banks can play with loan loss reserve levels to really smooth earnings. Securities transactions and (re)classifications are also good. Manufacturers mess with intellectual property, buybacks, good will, asset lives and other goodies to flatten results onto a nice rising curve and guarantee a nice beat. I just hated hearing all that. They quickly learned not to involve me. My superpower was creating the write up that made it all disappear into the legal ether.
!!! Lol!
Great post. Seems that our proliferating measures of inflation are merely on the same path as our multi-parsed earnings assessments – ex-energy, ex-financials, EBITDA, non-GAAP, ex-surcharge, pro-forma, etc, etc. You slice the baby enough, eventually you find a slice to your liking (or disliking).
I admit I like the concept of the SPX 493 and believe it has some validity, but it also seems more of a distortion to exclude the “Fab 7” to get a view of the “real economy” beneath the behomeths. I once consulted in Costa Rica as it was negotiating a free trade agreement with the US. Most of their national economic statistics were reported with or without Intel, which had built a plant there, attracted by a well-educated and mostly English-speaking workforce, and, of course, generous subsidies.
I ate a lot of abundant, cheap and very fresh pineapple down there while I tried to make sense of the bifurcated statistics, so much so that some of my hosts took notice that I diligently ate what they often considered just a garnish. I told them fresh pineapple was not that common nor that cheap in the US and they were stunned when I told then the typical US retail cost of a pineapple.
At the end of the day, the big picture realization that trade policy and deals had resulted in the US making pineapples while Costa Rica made semiconductors underscored the absurdity of it all. We diplomatically recommended against purusing the free trade agreement as drafted then, but they ultimately signed it 8 years later. Unfortunately, Intel shuttered the plant in 2014, which was a considerable setback. Now, facing supply squeezes, not to mention a generous round of new subsidies, Intel is back in Costa Rica, pouring $600 million to revive its old facility for a suddenly different-looking future.
This comment has meandered a bit from my original intent. Feel free to contact me for an ex-meandering version.