The Only Number that Matters this Earnings Season

For much of October, the government shutdown and the debt ceiling dominated the financial headlines. But corporate earnings have been the market driver.
The S&P 500 has risen 4.6% since the beginning of October, when the 16-day government shutdown began. Stocks initially pulled back in the first week of October as the reality of the government shutdown took hold and the Oct. 17 debt deadline loomed.
Then third-quarter earnings season began. Alcoa (NYSE: AA), the aluminum maker that is the unofficial earnings-season bellwether, kicked things off on Oct. 8 by beating EPS estimates by 105%. Stocks have scarcely had a down day since.
As it so often is, Alcoa’s earnings beat was a sign of things to come. Roughly three-quarters of S&P 500 companies have reported their Q3 earnings thus far, and 74% of them have beaten estimates. The 74% beat rate is ahead of the 70% average of the past four quarters, as well as the 73% beat rate of the past four years.
Other positives from this earnings season thus far are:

  • Eight of the 10 sectors in the S&P have reported higher earnings than they did in the third quarter a year ago.
  • Fifty-three percent of companies have beaten sales estimates in the third quarter, ahead of the 48% of the previous four quarters.
  • Information technology and consumer discretionary companies really flourished in the third quarter. Eighty-five percent of IT companies beat estimates, while 84% of consumer discretionaries came in ahead of expectations.

The news hasn’t been all good this earnings season, however. While a higher number of companies than usual have beaten earnings estimates, they’re exceeding those expectations by the skin of their teeth.
On average, companies have beaten earnings estimates by a mere 1.4% – the lowest percentage since the fourth quarter of 2008. Over the previous four quarters, S&P companies beat estimates by an average of 3.7%. The four-year average is even higher, at 6.5%.
The other troubling trend is that companies aren’t very optimistic about the current quarter.
Of the 79 S&P 500 companies that have issued guidance thus far, 66 of them – some 84% – are expecting negative year-over-year earnings growth in the fourth quarter. Corporate guidance is notoriously pessimistic. But 84% negative is rather high, well above the 63% five-year average.
So far, investors have focused more on the positives this earnings season.
Since Alcoa launched earnings season nearly a month ago, S&P 500 shares have shot up 6.5%. Lately, the index has been moving further and further into record territory. Clearly, investors aren’t terribly concerned about the pessimistic fourth-quarter guidance or the narrow earnings beats.
Investing behavior during earnings season is akin to how fans follow their favorite sports teams. Sports fans only care IF their teams win – not how close the score was. Most investors don’t have time to dig into the minutiae of every single earnings report. First and foremost, they look for one thing: did the company beat estimates?
More often than usual this earnings season, the answer has been “yes.”
For now, that’s been good enough to shepherd this market through a government shutdown and a near-default relatively unscathed.
Further Reading:
“As investors, we often worry about inflation eating into our returns. But might higher inflation rates actually be a good thing for the U.S. economy?” Read more here: Why Inflation Could Actually Help Your Portfolio
“We may be able to thank the government shutdown for slowing one of the great growth sectors of the U.S. economy: car sales.” Read more here: Thank the Government Shutdown for this Opportunity

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