Analysts expect strong third-quarter earnings growth, but forecasts aren’t getting a lift from the second quarter
The second-quarter earnings season has largely been positive for the U.S. stock market, a few high-profile disappointments aside. But increasingly, investors are looking for confirmation that the first half of the year won’t represent a peak for the cycle.
With the season more than half over, investors have begun to look past last quarter’s results and to expectations for what’s ahead. While companies are expected to post strong earnings and revenue growth next quarter, there is some concern that the strong results enjoyed thus far this reporting cycle won’t filter into the next three months.
According to FactSet, third-quarter earnings per share, also referred to as EPS, are seen growing 21.2%. That outlook has edged lower—not higher—over the past several weeks, despite the second-quarter season coming in above expectations. On June 1, about a month before the unofficial start to this reporting period, growth of 22.2% was anticipated for the coming quarter.
It isn’t uncommon for future expectations to be ratcheted up throughout a reporting season, particularly one that demonstrates both growth and which features a high percentage of companies topping expectations, as this one has, with 83% topping profit expectations.
According to Alec Young, managing director of global markets research at FTSE Russell, earnings expectations historically are raised by 300 basis points (or 3 percentage points) over the course of the quarter.
While Young said the second-quarter earnings season isn’t over—meaning that there was still time for forecasts to be lifted—and that the current consensus for third-quarter earnings remained extremely high, the lack of growing optimism about the future has been cited as a potential warning sign.
“This is not what we expected to see, given the magnitude of the beats so far for Q2. Our explanation (for now) it that the revisions will come as more companies report and analysts assimilate all that data into future earnings expectations,” wrote Nicholas Colas, co-founder of DataTrek Research, who in a follow-up said this view included all the earnings that had been released through July 27.
“We just wish analysts would pop their Q3 numbers sooner rather than later. The earnings pudding/sausage doesn’t get fresher with time.”
This issue could move into the forefront next week, as more than 140 S&P 500 companies are scheduled to report, including such major names as Apple Inc. AAPL, -2.55%, Procter & Gamble PG, -1.71%, and three other Dow components. Tesla Inc. TSLA, -2.01% the popular electric-car maker run by Elon Musk that has served as a proxy for risk sentiment, will also report.
The second-quarter season is unofficially seen as having started on July 13, with the release of results from such major financial institutions as JPMorgan Chase & Co. JPM, -1.68% Since the close of trading on July 12, the last trading day before the season, the Dow Jones Industrial Average DJIA, -1.43% has gained 2%, the S&P 500 SPX, -1.63% is up 0.9%, and the Nasdaq Composite Index COMP, -1.65%, which has recently been a laggard in the face of prominent earnings disappointments from the likes of Facebook Inc. FB, -1.70%, is down 1.3% thus far in 2018.
As of Friday, just over 52% of S&P 500 components have reported. EPS growth is seen coming in at 21.35%, while sales are expected to be up 9.1%.
Because roughly half the S&P 500 is still yet to report, analysts cautioned that it wasn’t necessarily notable that third-quarter expectations hadn’t moved in reaction to the latest results.
“It’s not a cause for concern yet. A lot will be priced in over the coming weeks, although it does kind of suggest that investors aren’t willing to reward large-cap equities” following strong results, said Martin Jarzebowski, portfolio manager at Federated Investors.
“The first two quarters of the year set a really high bar that will be hard for the third and fourth quarters of the year to follow through on, and that could represent a focal point for the market. Trade and strength in the U.S. dollar remain two international headwinds that could really dictate where profits go from here.”
Trade policy, centered on the imposition of duties on imports from other countries and vice versa, is widely seen as an issue that could hold back increases to future forecasts. While there are plenty of factors providing an underpinning to growth—including the tax-cut bill passed in December, which offered an immediate boost to profitability—details remain unclear, and the harm that heightened tariff tensions could have on global supply chains commodity prices and businesses also are uncertain.
Lindsey Bell, an investment strategist at CFRA Research, said the trade issue would determine whether the second quarter would represent a peak for growth. “Investors remain hopeful in the negotiating prowess of President Trump but we remind investors that a significant increase in tariffs could have a serious impact on the economy,” she wrote.
Jobs report, Fed meeting ahead
Among other notable events for the market next week, a read on June pending home sales will be released on Monday, followed by reads on consumer confidence, personal income and spending, and inflation on Tuesday.
However, the headline event includes a Friday nonfarm-payrolls report, which is expected to show 213,000 jobs added in the month, and the The Federal Reserve’s two-day policy meeting, which is set to conclude Aug. 1.
Although Chairman Jerome Powell’s Fed isn’t expected to make any major alterations to policy, the latest statement on the outlook for the economy against the backdrop of potential tariff wars, fiscal stimulus and President Donald Trump’s recent questioning of the monetary-policy strategy of the Fed are likely to be in focus.
Some attention also will be given to the Bank of Japan’s meeting after a series of reports suggesting that the central bank may be making tweaks to its approach.