by Tajinder Dhillon.
The peak-period of earnings season will begin over the next few weeks, where approximately 80% of constituents report. The current S&P 500 20Q4 earnings and revenue growth rate are -7.8% and -1.2% respectively.
In a typical quarter, year-over-year (YoY) growth expectations decline by an average of 3.6 percentage points (ppts) from the start of the quarter to the start of earnings season. However, 20Q4 YoY earnings have increased by 1.5 ppts over this period to -10.3% by Jan. 1, 2021. Consumer Discretionary saw the greatest improvement over this period, with YoY earnings increasing 3.0 ppts to -22.6% by Jan. 1. Conversely, the energy sector saw expectations decline by 2.8 ppts to -98.3%.
Seeing an increase in growth expectations heading into earnings season is a rarity. As shown in Exhibit 1, the growth rate does not typically improve heading into earnings season and has only done so six times over the last decade. The last time this occurred was in the most recent earnings season (20Q3), where earnings increased by 1.7 ppts. We also saw this momentum carry out through the quarter, as the 20Q3 growth rate improved from -21.4% at the start of earnings season to -6.5% at the end of earnings season. This resulted in a 14.9 percentage point gain during the quarter, which is the third largest improvement on record (dating back to 2002 Q3).
We are observing a similar trend in 20Q4, as the earnings growth rate has already improved from -10.3% to -7.8% in the beginning two weeks of earnings season.
Exhibit 1: S&P 500 Growth Rate Change Heading into Earnings Season
This raises the question if we see a similar improvement to earnings growth in 20Q4. Of the 26 constituents that have reported results thus far, 96.2% have beat earnings expectations alongside a surprise factor of 27.4%. This surprise factor is well-above the long-term surprise factor (since 1994) of 3.6%.
Over the past four quarters (19Q4-20Q3), the average earnings surprise factor has been 12.4%, which is largely contributed by the high surprise factor of 19.6% and 22.9% in 20Q2 and 20Q3 respectively. During these two quarters was the peak of the COVID-19 pandemic, where analysts aggressively cut estimates which created an easier benchmark for companies to beat expectations. If we assume this trend will continue in 20Q4 and apply the prior-four quarter average surprise factor of 12.4% to the companies yet to report, we could potentially see 20Q4 earnings growth improve from -7.8% to 2.4% by the end of earnings season.
Materials and Financials have the highest expected 20Q4 earnings growth of 8.9% and 6.9% respectively, while Energy (-101.8%) and Industrials (-42.3%) have the lowest expected earnings growth.
The Materials sector has the fourth smallest weight in the index on a market cap basis at 2.6% but is benefitting from a strong price environment in metals including copper, gold, and iron ore which all outperformed the S&P 500 in 2020. Iron ore increased 73.1% last year, while copper increased 26.2% and gold gained 24.8%. The Materials sector is expected to generate its first positive YoY earnings growth since 18Q4. Looking at an industry level, Metals & Mining is expected to deliver the lion share of earnings growth for the Materials sector in 20Q4 with an expected growth rate of 187.4%.
Analysts have also revised estimates upwards over the last 90 days when looking at the Aggregates app in Refinitiv Eikon. The FQ1 90-day mean estimate change for Metals & Mining has increased 18.7%, which is the 9th highest upward revision out of 63 industries within the S&P 500. Revenue estimates have also been revised upwards over the last 90 days by 4.9%.
Exhibit 2: S&P 500 Aggregate Revisions
The 20Q4 Industrials YoY earnings growth of -42.3% is driven by the Airlines industry group. The aggregate earnings growth rate for Airlines in 20Q4 is -321.4%. If we exclude Airlines, the Industrials growth rate improves from -42.3% to -8.9%. Airlines growth is expected to remain negative in 21Q1 at -97.6% before returning to positive territory in 21Q2. Delta Airlines reported 20EQ4 results last week and CEO Ed Bastian highlighted a similar narrative during the earnings call. “As the year progresses, we expect demand will start to accelerate as vaccinations become more widespread and the virus is in a contained state and customers gain greater confidence to make future travel commitments. This should enable a sustained recovery to begin in the second half of 2021 with a return to profitability this summer.”
Energy continues to operate in a difficult price environment as shelter-in-place and travel mobility restrictions remain in effect. The 20Q4 Energy YoY earnings growth rate of -101.8% marks the eight-consecutive quarter of negative earnings growth, which is the longest active losing streak of all sectors. Like Airlines, the sector is expected to return to growth in 21Q2.
Although Energy growth rates remain negative, many energy companies are expected to beat consensus expectations when looking at the StarMine Predicted Surprise. A StarMine Predictive Surprise compares the SmartEstimate to the I/B/E/S consensus, where the SmartEstimate places a higher weight on more accurate analysts and timely estimates. When the earnings Predicted Surprise % is +/-2% or more, our research shows that you can anticipate the direction of earnings surprises with an accuracy rate of over 70%. There are nine constituents within the sector that have a Predicted Surprise in excess of 2.0%. These include Chevron (68.5%), Exxon Mobil (23.6%), Nov Inc (8.5%), EOG Resources (4.3%), Devon Energy (4.1%), Kinder Morgan (4.0%), Pioneer Natural Resources (3.4%), Diamondback Energy (2.9%), and Baker Hughes (2.7%).
Every quarter, the Refinitiv Proprietary Research team predicts North American Companies that are expected to beat and miss earnings using the StarMine Predicted Surprise. In 20Q3, we scored 90% accuracy. To view the results, please click here.
Refinitiv Eikon is a complete solution for research and analytics. It places the most comprehensive market information, news, analytics and trading tools available into a desktop. Get unique value-add analytics and predictive financial modeling, dedicated to making investment research smarter with Refinitiv StarMine data.