How Strong is the Q2 Rebound?
Earnings aren’t the focus this week, with just two S&P 500 members – Constellation Brands (STZ) and Paychex (PAYX) – reporting results. The spotlight is on the economy, with investors trying to size up the Q2 rebound following a few disconcerting economic reads in recent days.
The ugly Q1 GDP read got easily dismissed as backward-looking and reflective of one-off weather distortions, with investors’ collective hopes pinned on a strong rebound in the current and following quarters. Recent data is forcing the market to reassess the growth outlook for the current period, with many realizing that the Q2 rebound may not be as strong as initially expected. Estimates for Q2 GDP growth have started coming down and the negative revisions trend could gain more momentum in the coming days if data continues to come on the soft side. Tuesday’s ISM survey and Thursday’s June jobs report will be key in that respect.
The Q2 earnings season will take the spotlight following the July 4th weekend, with Alcoa (AA) reporting results on the 8th. The aluminum producer will be the first S&P 500 member with fiscal quarter ending in June to report results; hence their claim to kick-start each reporting cycle. But from our perspective, companies with fiscal quarters ending in May get counted as part of the tally. In terms of this (official) definition, we will have seen Q2 results from 20 S&P 500 members. Not to make light of Alcoa’s bellwether status, at least in the Basic Materials sector, but a number of these early reporters with fiscal quarters ending in May like FedEx (FDX), Oracle (ORCL), Accenture (ACN) and others tell us a lot more about the state of corporate earnings.
It has been a mixed picture thus far, but it’s way too early to draw any conclusions at this stage. The chart below shows the number of S&P 500 members reporting results in the coming weeks. As you can see, we will have a decent enough sample size by the middle of the month to start making preliminary evaluations of this reporting season.
Estimates for Q2 have come down, largely in-line with the negative revisions trend that has been in place for quite some time, with the current expected growth rate of +2.9% down from +5.5% at the start of the quarter. The chart below shows the Q2 estimates have evolved over the last three months.
Despite the material negative revision, the +2.9% total earnings growth for the S&P 500 in Q2 is still more than double the growth pace we saw in Q1. The U.S. economy went through some unusual times in Q1, with GDP growth turning negative and corporate earnings growth barely remaining in the positive territory. The table below compares what is expected for Q2 with what was actually achieved in Q1.
Three sectors – Utilities, Consumer Discretionary, and Construction – will have double-digit earnings growth rates, while four will see earnings decline from the same period last year. The decliners list includes Finance, the largest earnings contributor in the S&P 500 index accounting for almost one-fifth of the index’s total earnings. Earnings for the sector were down last quarter and are expected to be no better this quarter either.
Looking at the constituent industries in the Finance sector, it is obvious that the growth challenge is particularly notable for the large banks. With persistently low interest rates keeping net interest margins under pressure and the mortgage business well past its prime, these operators are finding it difficult to deal with weakness in both the corporate as well as capital markets businesses. The resumption in M&A activity is a net positive, but isn’t enough by itself to move the needle for these huge entities.