After September lived up to its reputation as the worst month of the year, bulls are hopeful earnings will prove a welcome distraction for a stock market mired in weak seasonal trends and rising interest rates. Q3 earnings: Early signs are positive While most will date the start of earnings season to JPMorgan Chase’s report (it will be Oct. 13), there is a significant group reporting before it. This group has quarters that end in August, rather than September. So far, 16 companies have reported third-quarter earnings, all with August-ending quarters. They are a good indicator for the consumer and tech space and include FedEx, Oracle, Lennar, AutoZone, Darden, and Costco. Fifteen of the 16 beat on earnings, 69% beat on topline. “Net net, the earnings estimates for these early reporters are going up, and that is a positive sign for earnings season,” Earnings Scout founder and CEO Nick Raich from told me. Another positive sign: a record number of companies (116) have already issued earnings guidance for the fourth quarter, and a record number (104) have issued revenue guidance. More companies issuing guidance implies better visibility. “Thus, it appears more S & P 500 companies have confidence in their visibility on earnings over the near term compared to recent quarters, given the record-high number of S & P 500 companies issuing EPS and revenue guidance for the third quarter,” John Butters, senior earnings analyst at FactSet, said in a note Friday. The problem with this crop of August-ending quarters is that interest rates started creeping up again in September, which was one reason for the lousy performance of the S & P 500 . The first company to report a September-ending quarter will be Pepsi on Oct. 10. Valuations are coming down but are still high The forward multiple for the S & P 500 (Q4 2023, and Q1-Q3 for 2024) is 17.9. That is far lower than it has been for some time. In July, for example, with the S & P touching 4,600, the forward multiple was almost 20. The historic average is 17. Forward multiples above 17 imply optimistic expectations about earnings in the next year. The forward multiple is coming down because: 1) the S & P 500 is lower in price (almost 7% off the 52-week high in July) and 2) earnings estimates are going up. Earnings estimates for the third quarter began improving in August and continued to improve (modestly) in September, according to LSEG (formerly Refinitiv). Q3 S & P 500 earnings: trending higher Aug. 1: $55.67 Today: $55.92 Q4 S & P 500 earnings: trending higher Aug. 1: $57.55 Today: $58.14 Source: LSE The Q3 and Q4 estimates are rising mostly because of rising expectations in consumer discretionary, communication services, and technology, which were the sectors that led the initial rally in the first half of the year. These sectors are dominated by companies with very large market capitalizations. If any of those large companies have significant changes in their estimates, it can move the entire sector. That is exactly what we are seeing in the third quarter. For example, most of the increase in estimates in consumer discretionary is due to Amazon, General Motors, D.R. Horton, and Ford. Most of the increase in estimates for communication services is due to Meta, Netflix and Alphabet. Most of the increase in estimates for technology is due to NVIDIA, Apple, Intel, and Applied Materials. This works in the other direction as well. For example, industrials have seen a significant decline in earnings estimates due to very large estimate declines for Boeing. There has also been significant declines in earnings estimates for Southwest Airlines, American Airlines, and United Parcel Service. Bulls hopeful earnings will prove a welcome distraction The expectations for rising earnings has many hopeful that it will help get stocks out of their recent rut due to rising interest rates. The scenario of “stocks down/bonds down,” which was the September scenario, is not one anyone wants to see repeated in the fourth quarter. That’s the hope of Nicholas Colas, co-founder of DataTrek: “Once US stocks decouple from bonds, they will look for a new focal point of attention. This could be Q3 earnings announcements next month, which should be reasonably good,” he said in a recent note to clients. However, he also admitted that the knock-on effects of higher rates could be an issue on quarterly conference calls. Most strategists seem to agree with that assessment: How higher rates are affecting consumers will be the number one issue for the fourth quarter. Nick Raich from Earnings Scout is just hopeful the current modest uptrend in earnings will continue. “The key for bulls is just keeping Q4 estimates steady where they are now is an improvement from a few months ago,” he said. One other point Raich made: “I also expect the word ‘AI’ to pop up in a lot of earnings calls.”
