As Q3 earnings continue unfolding this week, the S&P 500 index stands down 2.0% YTD, and up 5.8% over the past year. It’s interesting to note that the top 3 sector returns YTD come from among the top 4 sectors expected to show the highest EPS YoY growth in Q3. So, regardless of the volatility in recent times, expectations may have been factored in pretty well into stock prices. Alongside, according to FactSet, if the S&P 500 reports a reduction in Q3 earnings, it will be the first back-to-back quarterly earnings decline since 2009. With relatively low bars set for results, here’s what we’re keeping an eye on this week:
The S&P 500 finds itself trading at 15.9x forward P/E – above its 5-year average of 14.1x and 10-year average of 14.0x (FactSet data). The index lost over 6% in Q3; at the same time, the dollar remained stable, and oil continued downwards. Q3 revenues are projected to decline 3.4% from the year earlier – following a drop of 3.3% in Q2, and 2.8% in Q1, per CNBC. As EPS growth drives stock returns, how companies cut costs will likely be the key focus for investors. Alongside, a slew of bank earnings this week should provide a critical data point on mortgage and housing trends. As of August, housing starts remained below historical averages, but US residential construction spending climbed above $36 billion – the highest monthly total since October 2007, per the WSJ. Auto sales, meanwhile, have also been robust throughout the summer – and alongside a 5.1% unemployment rate, a 10% U6 unemployment rate, and wage growth of over 2%, a tighter labor market should provide some optimism to investors.
Alongside, keep an eye on treasury yields. The 30-year yield curve began the year at 2.69%, and, in fact, finds itself at 2.9% today (unlike the 10-year, which has gone downwards). While the Fed Funds rate impacts the short end of the curve, long run expectations are driven by the market, and investors are still pricing in positive growth and higher inflation – albeit, lower than pre-recession levels. Things may not be all that bad. If you look further into sectors, IT spending is projected to outpace GDP growth by over 3%, and companies will look to tech firms to enhance productivity. Alongside, in light of weak emerging market demand, reducing global trade volume, geopolitical headlines and commodity weakness, we’re thinking domestic consumption may, in fact, be the biggest support for US equities ahead in Q4 – and they may find inflows simply because of a lack of options abroad. P/E expansion, as a result, shouldn’t be ruled out, and may also drive returns as the year progresses, given that earnings expectations remain dim.
What it means for you: Q3 earnings are going to be weak – and the market seems to have accepted it. Rather than simply dissecting the past, watch the guidance for Q4. The year end is likely to be filled with rate discussions, holiday consumption, and volatility. The Fed will remain on the watch list for the entire world. Given the reactions to the September FOMC communication, it wouldn’t be outlandish to expect officials to provide far more clarity to the markets as Q4 proceeds – removing uncertainty, which never helps. Regardless of the Fed decision, the fundamentals of several sectors remain strong – technology, financials, healthcare, and consumer stocks, and even domestic industrials, to name a few. Lackluster earnings and revenue declines continue to capture the media’s and Wall Street’s attention; we believe it’s wiser to tune out and look ahead. With the consumer leading the way, think about taking advantage of the weariness around earnings reports to snatch up some well-priced opportunities as quarterly reports unfold this week on Wall Street.
