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May 9, 2017

Earnings Roundup: Is the S&P 500 Showing Signs of Strength?

by David Aurelio.

The S&P 500 is on track to have its strongest quarter in more than five years, across multiple measures. Leading indicator sectors and industries point to sustainability and are accompanied by global growth that benefits multinationals. Additionally, company-issued guidance for 17Q2 indicates a positive outlook by management.

Exhibit 1: S&P 500 17Q1 Earnings Performance vs. Expectations

Source: I/B/E/S data

Heading into the final stretch of the 17Q1 earnings season, with roughly 13% S&P 500 companies remaining, the index is expected to post its highest year-on-year (Y/Y) earnings (14.5%) and revenue (7.2%) gains since 11Q3’s earnings grew 18.0% and revenue increased 11.1%. The index is also reporting earnings above expectations at a rate of 74.6%, which are 6.0% above expectations. The last time the earnings beats were this high was 10Q2, when earnings beat by 75.1%.

Exhibit 2: S&P 500 Y/Y Growth Rates

Part of the reason growth rates are elevated is due to a lift from the energy sector, which benefits from a low base. However, if the energy sector is excluded, Y/Y growth remains strong. Earnings ex-energy are expected to gain 10.2% and revenue to grow 5.3%. On a comparable basis, the last time the ex-energy growth rates were higher for earnings and revenue was in 11Q4, when earnings grew 14.1%, and 12Q4, when revenue increased 6.3%.

Exhibit 3: S&P 500 Y/Y Earnings Growth Rates by Sector

In addition to energy, there are several other indicators within the index that support improvement is sustainable. Financials are expected to grow 17Q1 earnings by 20.0%; materials by 19.0%, and information technology by 18.6%. Airlines are a drag on industrials; however, when they are excluded, the sector is expected to see earnings grow 9.3%. Additionally, a deep dive into information technology shows that the semiconductor and semiconductor equipment industry is expected increase earnings by 53%, while the IT services industry is expected to have the weakest gains (9.9%). When these two industries are excluded, the growth rate for the sector is expected to grow 12.9% from the prior year.

Exhibit 4: S&P 500 Y/Y CAPEX & R&D Expenses

Source: I/B/E/S data

In other words, core areas essential to sustainability are growing. Commodities and commodity like technologies are strong and growth in these areas are translating to growth in industrials and technology, with a strengthening financial backdrop. This can also be seen by increases to capex and R&D expenses.

Exhibit 5: Global 17Q1 Y/Y Growth, Miss, & Surprise Rates by Region

Thomson Reuters’ Earnings Season Report App. (EARN) within Eikon shows global growth. All major regions are expected to see Y/Y gains in 17Q1 earnings and revenue. In aggregate, blended SmartEstimates® project earnings to improve 23.2% and revenue to grow 5.2%. This global growth benefits the multinationals within the S&P 500.

Exhibit 6: S&P 500 % of FY2017 Revenue by Region/Country and Sector

Revenue by country is available for 74% of the S&P 500’s revenue. Of the companies that provide country-level detail, 40.8% is expected to be generated outside the U.S. Indeed, European Union (EU) countries are expected to generate 10.9% of revenue, with countries that use the euro accounting for 7.2% of S&P 500 revenue in FY2017. Developed Asia Pacific countries are estimated to produce 4.2%. The largest foreign contributors in the Asia Pacific region and the EU are China (5.9%), the UK (3.4%), Japan (2.6%), Germany (2.5%), and France (1.7%).

Information technology has the largest foreign revenue exposure (60.5%), with 26.1% of 2017 revenue expected to come from the Developed Asia Pacific region, China, India, and the Republic of Korea. The semiconductors and semiconductor equipment industry has one of the higher exposures to this region and these countries (53.6%), with the greatest exposure to China (32.7%), Singapore (7.3%), Japan (5.8%), and the Republic of Korea (5.2%). Comparisons to the percentage of domestic generated revenue (14.7%) and EU (6.2%) highlight the global supply gain for this high growth industry and the Asia Pacific region’s dominance in this area of advanced manufacturing.

It is important to interpret regional revenue in the context of the global supply chain because a large portion of revenue is generated abroad for materials and components. However, many of these are inputs into end products that have a high percentage of domestic revenue, which may partially explain discrepancies between strong U.S. earnings and weaker U.S. economic data.

Exhibit 7: S&P 500 17Q2 Pre-Announcements by Sector

Source: I/B/E/S data

Looking forward, guidance vs. expectations for 17Q2 is more positive than what is typically seen. The negative to positive (N/P) earnings ratio is 2.0, which is below the long-term average of 2.8. Revenue guidance is also positive, with an N/P ratio of 1.0, which is below the long-term average of 1.8. Earnings guidance is the most positive in the Information technology sector (0.8), while consumer staples are the most negative, with three negative guides and no positive guides. The median negative earnings guide is 3.5% below the mean at the time of guidance, while the median positive guide is 3.4% above.

Exhibit 8: S&P 500 17Q2 Revisions by Sector

Source: I/B/E/S data

In addition to relatively positive guidance, earnings and revenue revisions indicate positive sentiment for 17Q2 as well. On average, analysts tend to become more bearish, making downward revisions to estimates to the next quarter ahead of earnings season. This leads to an average reduction of -3.5% to earnings from the start of the prior quarter’s earnings season to the start of the current quarter’s earnings season. To date, earnings revisions to 17Q2 have reduced expected earnings by 1.5% and revenue by 0.5% since April 1, 2017. Reductions below the historic averages indicate analysts are more positive about 17Q2. Once earnings season begins, more companies tend to beat earnings, which lead to a median increase of 3.2% from the start to end of earnings season (i.e. Jul. 3, 2017 to Oct. 31, 2017 for 17Q2).

So far, this quarter has provided several factors that support sustainability and growth going forward. However, the final stretch is heavily focused on retailers and will provide important clues to consumer strength, which has been impacted by a digit shift in consumer interaction.

Please note: if you use our earnings data, please source I/B/E/S

Follow the S&P 500 earnings updates through the S&P 500 Earnings Dashboard.

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